Dynamics of Exchange Rate Volatility and Macroeconomic Indicators: A Panel VAR Study

Abstract

The paper intends to discuss the exchange rate volatility dynamics with respect to the macro-economic variables of GDP, interest rate, equity and foreign reserves. It models both the short and long-term relationships as a Panel Vector Autoregression (Panel VAR) model by allowing it to explore the way the economic shocks are transmitted by the networks through the interconnected markets. In the stationarity, the secondary panel data were first and then tested and lastly tested the unit root tests and impulse response functions with variance decomposition were also tested to find out the direction, the persistence and magnitude of these effects. It has been demonstrated that the interest rates and equity market movements are good predictors of the exchange rate volatility, whereas the foreign reserves are stabilizing factors in mitigating the effects of exchange volatility. The findings demonstrate the applicability of the right monetary and fiscal measures in achieving macroeconomic stability and decreasing the sensitivity to exchange rate risks, and meaningful information worth responding to financial strength to react to global economic shocks.