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Are exchange rates excessively volatile? And what does "excessively volatile" mean, anyway?

  • Leonardo Bartolini
  • Gordon M. Bodnar

Using data for the major currencies from 1973 to 1994, we apply recent tests of asset price volatility to reexamine whether exchange rates have been "excessively" volatile with respect to the predictions of the monetary model of the exchange rate and of standard extensions that allow for sticky prices, sluggish money adjustment, and time-varying risk premia. Consistent with previous evidence from regression-based tests, most of the models that we examine are rejected by our volatility-based tests. In general, however, we find that exchange rates have not been excessively volatile relative to movements of their determinants, with respect to the predictions of even the most restrictive version of the monetary model. Alternative measures of volatility, however, may disguise the cause of rejection as excessive exchange rate volatility.

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Paper provided by Federal Reserve Bank of New York in its series Research Paper with number 9601.

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Date of creation: 1996
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Handle: RePEc:fip:fednrp:9601
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