Towards Decoding Currency Volatilities

Abstract

This study contributes, on the basis of economic theory, to an explanation of exchange rate volatilities for a large number of currencies. We relate daily changes in GARCH (1,1) volatilities of exchange rates to the volatility changes of several of their presumed fundamental economic determinants. The us of high-frequency data limit the choice of the explanatory economic variables that can be included. The first differences of GARCH (1,1) volatilities of share and bond price indices proxy for wealth uncertainty and the later, in addition, for interest rate variability. Likewise, first difference of the gold price volatility, as an additional determinant, are related to exchange rate volatilities of two commodity currencies in the sample. The estimates produce coefficients with the expected signs and statistical significance.