Exchange Rate Volatility
Probably the most important characteristic of alternative exchange rate systems is the feature used to describe them, namely fixed or floating. Fixed exchange rates, by definition, are not supposed to change. They are meant to remain fixed for, ideally, a permanent period of time. Floating rates do just that—they float up and down, down and up, from year to year, week to week, and minute by minute. What a floating exchange rate will be a year from now, or even a week from now, is often very difficult to predict.
Volatility represents the degree to which a variable changes over time. The larger the magnitude of a variable change, or the more quickly it changes over time, the more volatile it is.
Since fixed exchange rates are not supposed to change, by definition, they have no volatility. A floating exchange rate may or may not be volatile depending on how much it changes over time. However, since floating exchange rates are free to change, they are generally expected to be more volatile. Volatile exchange rates make international trade and investment decisions more difficult because volatility increases exchange rate risk. Exchange rate risk refers to the potential to lose money because of a change in the exchange rate.
Source: “International Finance Theory and Policy”, by Steven M. Suranovic: www.internationalecon.com/Finance/F-toc.php
→ NOTE: http://internationalecon.com/Finance/Fch110/F110-1.php
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