Dynamic Impact Of Financial Structure On The Volatility Of The Real Exchange Rate

This study investigates the role of financial structure on the volatility of real effective exchange rates in Korea. (1). Historical developments of size, activity and efficiency of financial structure, including banking and nonblank financial institutions, are investigated for the last three decades in Korea. (2). Using the concept of bank-based and market-based financial structure, it is shown that there exists a stable long-run relationships between the financial structure of an economy and the volatility of real effective exchange rates. (3). Development of market-based system can successfully isolate foreign shocks and reduce the volatility of the real effective exchange rates while increased bank-based system destabilize the volatility of the real exchange. This can be explained by the strong requirement of information disclosure in the stock market induce risk-sharing activities of investors. (4). Policy implication is that transfer of risk from banking sector to stock market or non-bank financial institutions could stabilize the volatility of asset prices.