An emprical work on foreign exchange, inflation and interest rates volatility as a source of uncertainty for determining exchange rates: The case of Turkey

Due to the shock which is stemmed form the ending of the Bretton Woods?s system and rapid increases in oil prices, there have been volatilities and unstable conditions in the foreign exchange markets of the developed and developing countries. Welfare of the nations decreased because of national and international crises that lead to instability in foreign exchange market. Crises which are originated form the unstable structure of the foreign exchange markets of developing nations gave rise to the elaboration of new theories as to the determination of the exchange rates. In addition to these developments new techniques and approaches are introduced in the growing literature of econometrics.New policies are recommended in order to cope with the uncertainty cause by the exchange rate. The analysis about the external and internal balance is firstly introduced by the studies of Mundell and Fleming. Following the Keynesian approach of Mundell and Fleming, Monetarists have also focused on the theories as to the determination of exchange rates. Interest rates, money supply and expectations about the future played an important role in the determination of exchange rates as far as these theories are concerned.Proponents of these new approaches claim that the stabilizing policies of the central banks would probably increase the uncertainty in the exchange rate. By taking these approaches into account one can easily come to a conclusion that the most important issue is finding the source of the volatility in the exchange rates.In this study the effect of the shock which can be caused by the uncertainty in exchange rates, inflation rates, or interest rates is modelled by using the multivariate GARCH procedures. Data used in this study is monthly and covers the period of 1990-2007. We observed by using MGARCH-BEKK procedure that there is a spill over effect among the variables. Moreover it is observed in this study that the shocks have permanent effects over the variables.