THE EFFECT OF MACROECONOMIC VARIABLES ON EXCHANGE RATE VOLATILITY

Exchange rate stability is a fundamental property for economic development of a given country. It promotes price stability, stable economic growth and investments. However one of the major problems that foreign exchange market faces is volatility. The risk associated with high volatility levels in the foreign exchange market have cost implications for a number of economic agents as well as the economy as whole. Taking into account the aforementioned with the use of monthly exchange rates from January 1999 to March 2013 the aim of the current study was to determine, if any, the relationship between macroeconomic variable and exchange rate volatility. Four different macroeconomic variables have been used, namely openness of the economy, interest rate differential, unexpected news and inflation. To examine the potential relationship two different approaches have been used so as to examine the robustness of the results to changes in the methodology. From the results it can be suggested that the results are not robust to method of estimation supporting the part of the relevant literature that argues that the non-significance of the macroeconomic variable in explaining the changes of exchange rate volatility might come forth from the differences in the methodology and not to the variables as such. Even though in the current study there was not a strong support for the existence of a relationship between macroeconomic variable and exchange rate volatility, while under GARCH methodology the relationship was found to be none, under EGARCH approach in different series certain variables were found to be statistically significant. As certain previous studies suggested, the magnitude and significance of macroeconomic variable on exchange rate volatility depend on the economic conditions of a given country.