EXPLAINING EXCHANGE-RATE VOLATILITY - AN EMPIRICAL-ANALYSIS OF THE HOLY TRINITY OF MONETARY INDEPENDENCE, FIXED EXCHANGE-RATES, AND CAPITALMOBILITY

This paper uses a panel of data from twenty-two countries between 1967 and 1992 to explain exchange rate volatility, focusing on potential t radeoffs between fixed exchange rates, independent monetary policy, an d capital mobility. I use monetary models to parameterize monetary div ergence and factor analysis to measure capital mobility. Exchange rate volatility is loosely linked to both monetary divergence and the degr ee of capital mobility. Interestingly, exchange rate volatility is sig nificantly correlated with the width of the explicitly declared exchan ge rate band, even after taking monetary divergence and capital mobili ty into account. (JEL F31, F33). Copyright (C) 1996 Elsevier Science L td.