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Understanding Bilateral Exchange Rate Volatility

  • Devereux, Michael B
  • Lane, Philip R.

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 exchange 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 C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3518.

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Date of creation: Aug 2002
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Handle: RePEc:cpr:ceprdp:3518
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  1. Michael B. Devereux & Philip R. Lane, 2000. "Exchange Rates and Monetary Policy in Emerging Market Economies," Working Papers 072000, Hong Kong Institute for Monetary Research.
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  25. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
  26. Gerard Caprio, Jr. and Patrick Honohan, 2008. "Banking Crises," The Institute for International Integration Studies Discussion Paper Series iiisdp242, IIIS.
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  28. Larrain Felipe & Jose Tavares, 2003. "Regional Currencies Versus Dollarization: Options for Asia and the Americas," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 6(1), pages 35-49.
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