Determinants of exchange rate volatility: empirical evidence for Turkey

Abstract

Purpose- In the literature the effect of exchange rate volatility on various macroeconomic variables has been extensively studied but there are not enough studies about the reasons of exchange rate volatility. The aim of the research is to present the theoretical framework about the determinants of exchange rate volatility and to determine the factors affecting exchange rate volatility in Turkey for a period from 1974 to 2016. Methodology- In this research the stationary analysis of the series is determined by the Augmented Dickey Fuller Test (ADF) and the PP (Phillips-Perron test) unit root tests. In addition the GARCH model is used to calculate the real effective exchange rate volatility. The Johansen cointegration test is used to determine whether there is a long-term relationship between variables. The coefficients of the long-run relationship between the variables are estimated by the FMOLS method. Findings- The ADF and PP unit root test results show that the series are stationary at first difference. According to Johansen cointegration test results, it has been found that there is a long-run relationship between the variables involved in the analysis. Results from the FMOLS method for determining the direction and severity of the long-term relationship between the variables reveal that LGFCF, LMONEY and LTRADE positively affects significantly, while LFDI, LGDPC, LGGEXP negatively affects real effective exchange rate volatility. Conclusion- The rise in domestic investment (LGFCF), money supply (LMONEY) and trade openness (LTRADE) increases the real effective exchange rate volatility, while the rise in foreign direct investment (LFDI), output (LGDPC) and government expenditures (LGGEXP) also reduces the real effective exchange rate volatility.