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Understanding Bilateral Exchange Rate Volatility

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Author Info
Michael B. Devereux
Philip R. Lane

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Abstract

This paper develops an empirical model of bilateral exchange rate volatility. We conjecture that for developing economies, external financial liabilities have an important effect on desired bilateral exchange rate volatility, above and beyond the standard Optimal Currency Area (OCA) factors. By contrast, industrial countries do not face the same set of constraints in international financial markets. In our theoretical model, external debt tightens financial constraints and reduces the efficiency of the exchange rate in responding to external shocks. We go on to explore the determinants of bilateral exchange rate volatility in a broad cross section of countries. For developing economies, bilateral exchnage rate volatility (relative to creditor countries) is strongly negatively affected by the stock of external debt. For industrial countries however, OCA variables appear more important and external debt is generally not significant in explaining bilateral exchange rate volatility.

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Paper provided by Trinity College Dublin, Department of Economics in its series Trinity Economics Papers with number 200211.

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Date of creation: 2002
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Handle: RePEc:tcd:tcduee:200211

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  1. Alberto Alesina & Robert J. Barro, 2002. "Currency Unions," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 409-436, May. [Downloadable!] (restricted)
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  2. Maurice Obstfeld & Kenneth Rogoff, 1996. "Exchange Rate Dynamics Redux," NBER Working Papers 4693, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Frankel, Jeffrey A & Rose, Andrew K, 1996. "The Endogeneity of the Optimum Currency Area Criteria," CEPR Discussion Papers 1473, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  4. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December. [Downloadable!] (restricted)
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  5. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2001. "Currency crises and monetary policy in an economy with credit constraints," European Economic Review, Elsevier, vol. 45(7), pages 1121-1150. [Downloadable!] (restricted)
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  6. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February. [Downloadable!] (restricted)
  7. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  8. Bayoumi, Tamim & Eichengreen, Barry, 1998. "Exchange rate volatility and intervention: implications of the theory of optimum currency areas," Journal of International Economics, Elsevier, vol. 45(2), pages 191-209, August. [Downloadable!] (restricted)
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  9. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August. [Downloadable!] (restricted)
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  10. Michael B. Devereux & Philip Lane, 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," CEG Working Papers 20017, Trinity College Dublin, Department of Economics. [Downloadable!]
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  11. Andrew K. Rose & Charles Engel, 2000. "Currency Unions and International Integration," NBER Working Papers 7872, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May. [Downloadable!] (restricted)
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  14. FELIPE LARRAÍN B. & JOSÉ TAVARES, 2003. "Regional Currencies Versus Dollarization: Options for Asia and the Americas," Journal of Policy Reform, Taylor and Francis Journals, vol. 6(1), pages 35-49, March. [Downloadable!] (restricted)
  15. Carmen M. Reinhart & Kenneth S. Rogoff, 2002. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," NBER Working Papers 8963, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Eichengreen, Barry, 2002. "When to Dollarize," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 1-24, February.
  17. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2001. "External constraints on monetary policy and the financial accelerator," Proceedings, Federal Reserve Bank of San Francisco, issue Mar. [Downloadable!]
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  18. Honohan, Patrick & Lane, Philip R, 1999. "Pegging to the Dollar and the Euro," International Finance, Blackwell Publishing, vol. 2(3), pages 379-410, November. [Downloadable!] (restricted)
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  19. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  20. Ricardo Caballero & Arvind Krishnamurthy, 2001. "A "Vertical" Analysis of Crises and Intervention: Fear of Floating and Ex-ante Problems," NBER Working Papers 8428, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  21. Hélène Poirson, . "How Do Countries Choose Their Exchange Rate Regime?," IMF Working Papers 01/46, International Monetary Fund. [Downloadable!]
  22. Claudia M. Buch, 2001. "Distance and International Banking," Kiel Working Papers 1043, Kiel Institute for the World Economy. [Downloadable!]
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  23. Caroline van Rijckeghem & Beatrice Weder, 2000. "Spillovers Through Banking Centers - A Panel Data Analysis," IMF Working Papers 00/88, International Monetary Fund.
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