Liberalized Markets Have More Stable Exchange Rates: Short-Run Evidence From Four Transition Countries

February 1, 2004

Preview Citation

Format: Chicago

Ales Bulir. Liberalized Markets Have More Stable Exchange Rates: Short-Run Evidence From Four Transition Countries, (USA: International Monetary Fund, 2004) accessed December 24, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

The paper looks at the hypothesis that financial market liberalization can create a basis for more stable exchange rates, as deviations of exchange rates from equilibrium levels bring forth stabilizing flows of liquidity. This "endogenous liquidity" hypothesis suggests that opening financial markets militates in favor of exchange rate flexibility by increasing the viability of a floating regime, as well as making it more difficult to maintain a peg. The paper examines this hypothesis in a sample of four transition economies and finds that exchange rates tend to return faster to their Hodrick-Prescott-based values where markets are liberalized. The results suggest that early and successful foreign exchange liberalization pays off in terms of depth of the market and, hence, faster adjustment of exchange rate to shocks. Moreover, it implies that central banks should not be overly concerned with short-run volatility of their national exchange rates, given the self-correcting tendencies.

Subject: Asset and liability management, Currency markets, Exchange rate arrangements, Exchange rates, Financial markets, Foreign exchange, Liquidity

Keywords: Coefficient of determination, Currency markets, Endogenous liquidity, Error-correction mechanism, Euro exchange rate return, Europe, Exchange rate, Exchange rate arrangements, Exchange rate volatility, Exchange rates, Hungarian forint, Liquidity, Market, Market liquidity, Mean reversion, Nonlinearity, Order flow, U.S. dollar, Western Europe, WP

Publication Details

Pages:

32
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2004/035
Stock No:

WPIEA0352004
ISBN:

9781451845389
ISSN:

1018-5941

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