Asymmetric Effect of Currency Substitution on Exchange Rate Volatility in Iran: Markov-Switching Approach

Document Type : Scientific-research

Authors

1 Assistant Professor, Department of Economics, University of Kurdistan, Sanandaj, Iran

2 M.A in Economics, University of Kurdistan, Sanandaj, Iran

10.30465/ce.2022.41635.1793

Abstract

One of the most important factors influencing the exchange rate volatility is currency substitution due to the dollarization of the economy. Currency substitution is a common phenomenon in developing countries. The purpose of this study is to investigate the asymmetric effect of currency substitution on exchange rate volatility in Iran. In this study, the quarterly data of Iran's economy during the period 1990-2021has been used by applying the Bound test method and autoregressive with distributive Lag and Markov switching methods. Based on the results, Model MSIH(2)-AR(2) was chosen as the optimal model. In addition, in measuring the amount of money, due to the important role of defining the amount of money from monetary aggregates, simple sum and Divisia are used. The results show that the Divisia monetary aggregate is more appropriate than the simple sum in the expression of asymmetries. Currency substitution in the low-volatility regime had a negative effect on exchange rate volatility, but in the high-volatility regime, the effect of currency substitution was significantly positive. It illustrates the asymmetry effect of currency substitution on exchange rate volatility in various exchange rate regimes and confirms the asymmetric effect of currency substitution on exchange rate volatility.

Keywords

References

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Journal of Iranian Economic Issues
Volume 9, Issue 2
October 2022
Pages 217-245

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History

  • Receive Date: 11 June 2022
  • Revise Date: 08 August 2022
  • Accept Date: 07 October 2022

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