A Panel-Regression Investigation of Exchange Rate Volatility

This paper offers an empirical explanation behind the dynamics of the overall volatility of exchange rates and its high-frequency, most economically destabilizing components. Spectral methodology is employed to isolate the portion of volatility attributable to high-frequency components, and panel regressions are used to relate the volatility measures to various macroeconomic and policy variables. Given the estimated panel regressions, the paper suggests policies that may help reduce exchange rate volatility in general and along high-frequency components in particular, thereby contributing to financial stability. The paper shows that while the macroeconomic and policy variables affecting the high-frequency components of volatility and overall volatility are generally similar, there are some important differences. The paper also highlights the divergent impacts of policy variables in developed vis-à-vis developing economies. The results are robust with respect to using alternative cut-off frequencies and estimation methods. The presented analysis may help to gain an understanding of the determinants of the most destabilizing components of exchange rate volatility and provide guidance into managing currency crises.