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Liberalized Markets Have More Stable Exchange Rates: Short-Run Evidence from Four Transition Countries

  • Aleš Bulíø

    ()

    (International Monetary Fund)

The paper looks at the hypothesis that financial-market liberalization can create a basis for more stable exchange rates, as deviations of exchange rates from equilibrium levels bring forth stabilizing flows of liquidity. This hypothesis suggests that opening up financial markets militates in favor of exchange-rate flexibility by increasing the viability of a floating regime as well as making it more difficult to maintain a peg. The paper examines this hypothesis in a sample of four transition economies and finds that exchange rates tend to return faster to their Hodrick-Prescott-based values where markets are liberalized. The results suggest that early and successful foreign-exchange liberalization pays off in terms of depth of the market and, hence, faster adjustment of the exchange rate to shocks. Moreover, it implies that central banks should not be overly concerned with short-run volatility of their national exchange rates.

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Article provided by Charles University Prague, Faculty of Social Sciences in its journal Finance a uver - Czech Journal of Economics and Finance.

Volume (Year): 55 (2005)
Issue (Month): 5-6 (May)
Pages: 206-231

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Handle: RePEc:fau:fauart:v:55:y:2005:i:5-6:p:206-231
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  1. Michael B. Devereux & Philip R. Lane, 2002. "Understanding Bilateral Exchange Rate Volatility," Trinity Economics Papers 200211, Trinity College Dublin, Department of Economics.
  2. Siklos, Pierre L. & Granger, Clive W.J., 1997. "Regime-Sensitive Cointegration With An Application To Interest-Rate Parity," Macroeconomic Dynamics, Cambridge University Press, vol. 1(03), pages 640-657, September.
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  11. repec:cup:macdyn:v:1:y:1997:i:3:p:640-57 is not listed on IDEAS
  12. 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.
  13. Derviz, Alexis, 2004. "Asset return dynamics and the FX risk premium in a decentralized dealer market," European Economic Review, Elsevier, vol. 48(4), pages 747-784, August.
  14. Timothy Cogley & James M. Nason, 1993. "Effects of the Hodrick-Prescott filter on trend and difference stationary time series: implications for business cycle research," Working Papers in Applied Economic Theory 93-01, Federal Reserve Bank of San Francisco.
  15. Kim, Soyoung, 2003. "Monetary policy, foreign exchange intervention, and the exchange rate in a unifying framework," Journal of International Economics, Elsevier, vol. 60(2), pages 355-386, August.
  16. Alexis Derviz, 2003. "Components of the Czech Koruna Risk Premium in a Multiple-Dealer FX Market," Working Papers 2003/04, Czech National Bank, Research Department.
  17. Hamid Faruqee & Lee Redding, 1999. "Endogenous Liquidity Providers and Exchange Rate Dynamics," Canadian Journal of Economics, Canadian Economics Association, vol. 32(4), pages 976-994, August.
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