Skip to content
All library documents

Measuring Exchange Rate Volatility After Euro Adoption

Article Quant Q&A · Author: rhorvath
Read the original

Summary

The document considers how to measure Slovakia’s exchange rate volatility against the euro after Slovakia adopted the euro. It explains that the former koruna-to-euro exchange rate became fixed at the conversion rate, so volatility for that bilateral rate is zero after conversion. For a currency pair, realized volatility is typically estimated from changes in the log exchange rate; a constant rate therefore has no realized volatility.

The discussion also points out that a single bilateral rate may not capture a country’s broader exposure to currency fluctuations. Slovakia continued trading with countries outside the euro area, so a trade-weighted effective exchange rate, built from multiple bilateral rates using trade weights, may better suit an international trade analysis. The document does not specify which measure is best for a particular research objective, nor does it compare effective exchange rate construction methods. Replacing the euro with the US dollar for Slovakia and other countries is raised as a possible approach but not endorsed or evaluated.

Key ideas

  • A fixed koruna-to-euro conversion rate implies zero post-conversion volatility for that bilateral rate.
  • Realized exchange rate volatility can be measured from changes in the log exchange rate.
  • A trade-weighted effective exchange rate combines multiple bilateral rates according to trade weights.
  • The appropriate currency measure depends on whether the analysis concerns bilateral exposure or broader trade-weighted exposure.

Tags

ForexVolatilityStatistics
Full text
# How to handle currency change in exchange rate volatility measurement


# How to handle currency change in exchange rate volatility measurement












I am trying to measure exchange rate volatility in some countries and I am using their currencies against euro. Problem is that one of them is Slovakia which has changed the currency in 2009 from crown to euro. From that year there is no way for me to measure its exchange rate against euro, because it is using euro (obviously). How would you suggest to solve this issue in the most correct way?

Approach I think of is comparing Slovakia currency for the whole time period against USD, but I am afraid this might introduce another problems (inaccuracies?) into my results. Also, if I do so, should I measure the other countries against USD and not EUR as well?

## Answer by closedloop (score 1, accepted)

https://quant.stackexchange.com/a/19446

The volatility goes to 0 once the crown is pegged to the Euro.

The value of an exchange rate between Currency1 and Currency2 the the ratio of the value of Currency1/Currency2. The realized volatility of a currency pair is the usually measured as some trailing average of the daily log-changes in this ratio.

After the conversion was made the crown at a ratio of 30.1260 crowns to 1 Euro, this ratio hasn't changed and therefore the exchanged rate is fixed. The volatility of a constant series is 0.

## Answer by nbbo2 (score 1)

https://quant.stackexchange.com/a/19465

I am not sure what the purpose of your volatility calculation is. So, frankly, the question does not make 100% sense to me.

However, countries do not engage in trade with just one other country but with many, so from an International Trade Theory point of view looking at a single bi-lateral rate (even an important one like SLOVAKIA/EUR) is not enough. Slovakia no longer experiences currency fluctuations with its eurozone partners, but it still trades (presumably) with USA, China, etc. So you should consider looking at an Effective Exchange Rate for Slovakia. EER's are computed by central banks or national statistics institutes by a mathematical formula that essentially averages together many bilateral exchange rates in proportion to how much the country trades with those countries. [In fact they are sometimes called trade weighted exchange rates].

Hope this helps.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.