Sources of exchange rate fluctuations and volatility transmission in five Southeast Asian countries

Abstract

This research aims to investigate exchange rate behaviors in various aspects, especially 1) sources of exchange rate fluctuations: the pass-through effects of key macroeconomic variables on the exchange rate and 2) volatility transmission of exchange rate among five Southeast Asian countries namely Indonesia, Malaysia, the Philippines, Singapore and Thailand. For research methodologies, this study employs a number of tools since it consists of two main features of exchange rate behaviors like sources of exchange rate fluctuations and volatility transmission of exchange rate among the selected countries. The former uses Vector Autoregressive (VAR) model with application of cointegration test, error correction model, impulse response analysis and variance decomposition is motivated to choose the list of variables to capture importance sources of fluctuations. The latter uses multivariate GARCH model to analyze the exchange rate volatility transmission among these countries. The results are also compared to the other measures like bi-variate analysis of impulse response and causality tests as well. The results from the VAR analysis with its application including cointegration test, vector error correction model (VECM) suggest that first, all selected key macroeconomic variables are cointegrated for all of the selected countries. In other words, they have long run equilibrium. For short run, the results from VECM reveal that these countries can be achieved error correction mechanism in some of key macroeconomic variables. This means that there exists the convergence process. Second, these macroeconomic variables have affected exchange rate fluctuations from impulse response analysis and variance decomposition analysis. The results show the instability in exchange rate movements in the case of Indonesia comparing to other countries in this region. However, Singapore has the most exchange rate stability. In summary, these results imply that changes in key macroeconomic variables are probably accompanied by exchange rate fluctuations. For exchange rate volatility transmission, the results from multivariate GARCH model revealed that there are some evidences for direct and indirect volatility transmission across the currencies in this study. The volatility also generates from both its own markets and cross-markets. This supports to the hypothesis that comovements of exchange rates in this region can explain the rapid transmission especially in post-crisis period. As a result, most of the cross-currency interactions seem to stem from the co-movements of exchange rates over time. The results of estimating from impulse response analysis suggest that most of them respond to contemporaneous change from another currency in both periods of time. An exception is Thai baht, which move quite independently from any other currencies during the pre-crisis period. The response of one currency to another currency in the post crisis period seems to be smaller than the previous one. As a result of most of these countries adopting the floating exchange rate regime that automatically adjusts, they enable a country to resist the impact of shocks. Granger causality analysis shows the significant of the cause and effect between currencies in this region. The major finding implies that changes in key macroeconomic variables are likely to be accompanied by exchange rate fluctuations and higher volatility transmissions of these currencies in the post-crisis period. To achieve a financial stability, policy makers should provide an overall basket of incorporated policies and instruments not only the exchange rate interventions but also other factorsdeveloping and strengthening financial system, and strengthen macroeconomic policies. In addition, central banks in the member state should conduct exchange rate policy on a regional basis in order to cope with any shocks and exchange rate volatility.