This paper investigates the determinants of exchange rate volatility in South Africa for the period 1986-2013 using the New Open Economy Macroeconomics model by Obstfeld & Rogoff (1996) and Hau (2002). The main focus of the paper is to test the hypothesis that economic openness decreases Rand (ZAR) volatility. This follows South Africa's liberalisation of its capital account in the mid-1990s and the mixed results in the literature on the relationship between exchange rate volatility and economic openness. Employing monthly time series data, GARCH models are estimated. The study finds that switching to a floating exchange rate regime has a significant positive effect on ZAR volatility. The results also indicate that trade openness significantly reduces ZAR volatility only when bilateral exchange rates are used, but finds the opposite when multilateral exchange rates are used. The study also finds that volatility of output, commodity prices, money supply and foreign reserves significantly influence ZAR volatility.
The Determinants of Exchange Rate Volatility in South Africa
Working paper 604