IDEAS home Printed from
MyIDEAS: Log in (now much improved!) to save this paper

Exchange Rate Regimes and the Volatility of Financial Prices: The Australian Case

Listed author(s):
  • Robert G. Trevor

    (Reserve Bank of Australia)

  • Stephen G. Donald

    (Reserve Bank of Australia)

Much has been written about the choice of exchange rate regimes from a theoretical perspective. A conclusion of this literature is that, ceteris paribus, interest rates should exhibit less volatility (and exchange rates more volatility) under a floating than under a fixed exchange rate regime. Equivalently, interest rates should be relatively easier (and exchange rates relatively harder) to predict (in the statistical sense) under a floating exchange rate. Further, the unexpected volatility in interest rates due to external impulses should be reduced, and that in exchange rates increased, relative to a fixed exchange rate regime. This study analyses the question of interest rate and exchange rate volatility before and after the floating of the Australian dollar in December 1983. The paper adopts an atheoretical methodology of vector autoregressions (VAR’s) to calculate the forecast-error variance for interest rates and exchange rates (at different horizons) and to decompose these forecast-error variances into those parts attributable to domestic and external sources. A VAR model is estimated for both the pre- and post-float periods, on daily data for the Australian trade-weighted index, the Australian 90 day bank accepted bill rate, the US trade-weighted index, the US 90 day prime bankers’ acceptances rate, the DM trade-weighted index, the West German 90 day interbank deposits rate, the Japanese trade-weighted index and the Japanese 90 day Gensaki rate. This is the minimum configuration that can capture both domestic and foreign sources of volatility in financial prices. The analysis supports the hypothesis that interest rates have become relatively less volatile (and the exchange rate relatively more volatile) with the move to a floating exchange rate regime. However, the evidence suggests that this has been due to a change in the nature of the relationship between the Autralian interest rate and exchange rate; rather than a shift in the incidence of external shocks. This supports the notion that a more independent monetary policy is possible under a floating exchange rate regime.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: no

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp8608.

in new window

Date of creation: Jul 1986
Handle: RePEc:rba:rbardp:rdp8608
Contact details of provider: Postal:
GPO Box 3947, Sydney NSW 2001

Phone: 61-2-9551-8111
Fax: 61-2-9551-8000
Web page:

More information through EDIRC

No references listed on IDEAS
You can help add them by filling out this form.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:rba:rbardp:rdp8608. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Paula Drew)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.