The long-run volatility puzzle of the real exchange rate

This paper documents large cross-country differences in the long-run volatility of the real exchange rate. It shows that the real exchange rate of developing countries is approximately three times more volatile than the real exchange rate in industrial countries. The paper shows that this difference in volatility cannot be explained by the fact that developing countries face larger shocks (both real and nominal), recurrent currency crises or by different elasticities to these shocks. ARCH estimations find a much higher persistence of deviations of the variance of the RER from its long-run value when the economy suffers shocks of various kinds. (c) 2005 Elsevier Ltd. All rights reserved.