Abstract
Real exchange rate volatility is an important contributor to risks in the financial world. During periods of excessive fluctuations in exchange rates, foreign trade and investments could be affected negatively. The objective of this study is to determine the sources of exchange rate volatility in Ghana. The methodology employed is a dynamic econometric technique based on the Autoregressive Distributed Lag (ADL) Model to account for psychological inertia among others. The study used annual data covering the period 1980 to 2012 to investigate the determinants of real exchange rate volatility in Ghana. Consistent with the empirical literature, government expenditure is a major determinant of real exchange rate volatility. There existed a positive relationship between them. Further, both domestic and external debts were negatively related to real exchange rate volatility. Current external debt and a four year lag of domestic debt had significant impacts on real exchange rate volatility. The main contribution of this paper is empirical and methodological. Empirically, it adds new empirical evidence and new dimensions to the literature on determinants of exchange rate volatility in developing economies. Key words: Exchange rate volatility, Generalized Auto-Regressive Conditional Heteroscedasticity, autoregressive distributed lag.
Highlights
Exchange rate volatility is an important contributor to risks in the financial world
Consistent with the empirical literature, government expenditure is a major determinant of real exchange rate volatility
Since Government expenditure is always increasing following Wagner’s law, it is the increase in volatility that is important for the study
Summary
Exchange rate volatility is an important contributor to risks in the financial world. Following Baig (2001) and Hviding et al (2004), the collapse of the Bretton Woods Institution in 1973 led to an increase in real interest rate volatility. This occurrence led to a switch from fixed to floating exchange rates and this had marked effects on economic growth, capital movements and international trade. According to Stancik (2007), several factors explain the source of exchange rate volatility. Among them he outlined the domestic and foreign money supply, inflation, level of output and the exchange rate regime.
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