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SOURCES OF REAL EXCHANGE RATE VOLATILITY AND INTERNATIONAL FINANCIAL INTEGRATION: A DYNAMIC GENERALISED METHOD OF MOMENTS PANEL APPROACH

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Abstract

The aim of this paper is to provide some new empirical evidence on the determinants of volatility of real exchange rates in emerging countries, focusing on the role of international financial integration in particular. A reduced-form model is estimated using the generalised method of moments for dynamic panels over the period 1979–2004 for a sample of 39 developing countries grouped into three regions (Latin America, Asia and MENA). Our findings suggest that different types of shocks (external, real and monetary) can account for the volatility of real exchange rates in emerging economies, with international financial integration being a major driving force. Therefore, financial liberalisation and integration should be pursued only gradually in emerging countries. Copyright © 2011 John Wiley & Sons, Ltd.

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