Are Exchange Rates Excessively Volatile? and What Does "Excessively Volatile" Mean, Anyway?

IMF Working Papers, August 1, 1995

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Are Exchange Rates Excessively Volatile? and What Does "Excessively Volatile" Mean, Anyway?

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Bibliographic details

• Authors: Gordon M. Bodnar, Leonardo Bartolini
• Published: August 1, 1995
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451850697.001

Study and Methods

• Objective: Re-examine whether exchange rates have been excessively volatile with respect to the predictions of the monetary model of the exchange rate and standard extensions (sticky prices, sluggish money adjustment, time-varying risk premia).
• Approach: Apply recent tests of asset price volatility (volatility-based tests) to exchange rates for the major currencies.
• Comparison: Results evaluated against previous regression-based tests.

Data and Sample

• Currency coverage: Major currencies.
• Sample period: 1973 to 1994.

Key Findings

• Model rejections:
  • "Most of the models that we examine are rejected by our volatility-based tests."
  • This result is "consistent with previous evidence from regression-based tests."
• Volatility conclusion:
  • "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."
• Caveat on measures:
  • "Alternative measures of 'volatility', however, may disguise the cause of rejection as excessive exchange rate volatility."

Interpretation and Implications

• Despite model rejections, the observed exchange rate variability is broadly in line with determinants implied by monetary-model predictions, including its most restrictive form.
• Rejection of models can arise from measurement or test-choice issues; different volatility measures can lead to attributing rejection to exchange rate excess volatility when the underlying cause may differ.

Notes for Readers

• This is a Working Paper; the author(s) "would welcome any comments on the present text."
• Disclaimer: "The views expressed are those of the author(s) and do not necessarily represent those of the Fund."

Source: IMF Working Papers — Are Exchange Rates Excessively Volatile? and What Does "Excessively Volatile" Mean, Anyway? by Gordon M. Bodnar and Leonardo Bartolini, August 1, 1995.