Variance Bounds as Thresholds for ‘Excessive’ Currency Volatility: Inflation Targeting Emerging Economies
Shaista Amod and Shakill Hassan
Last Modified Date:
2021-12-08, 10:16 AM
Publications > Working Papers
At what level does a currency’s volatility become ‘excessive’, in a concrete sense? Any claim that an exchange rate is excessively volatile needs a benchmark for ‘normal’ variability. We compute variance bounds implied by exchange rate models as the norm, for a set of particularly volatile emerging market currencies; and find that long-run exchange rate volatility does not breach the upper bound implied by the present value of underlying fundamentals - for each currency in our sample, except the Brazilian real. However, nominal exchangerate variances get closer to implied upper bounds under inflation targeting. We also find a reduction in real exchange rate misalignment under inflation targeting.