The euro and the volatility of exchange rates

Abstract

This article attempts to determine whether or not the introduction of the euro affected the volatility of major bilateral exchange rates. To this end, we examine the exchange rate behaviour for a set of Organization for Economic Co-operation and Development (OECD) and non-OECD countries during the period 1993 to 2010. We find evidence of structural breaks in volatility across investigated variables and, although there is a high heterogeneity regarding the located dates, our results suggest a reduction in volatility associated with European Economic and Monetary Union (EMU) and worldwide shocks and an increase in volatility following shocks originating outside EMU. The decomposition of total volatility into its components suggests that the permanent component tracks total volatility reflecting the evolution of fundamental factors, and the transitory component responds largely to market fluctuations, rising during the detected structural breaks.