What determines the extent of real exchange rate misalignment in developing countries?

The paper seeks to explain the extent of real exchange rate misalignment, defined as its deviation from its equilibrium level. It enlarges the traditional analysis, which focuses mainly on the role of nominal exchange rate regimes, to consider the role of the quality of institutions and financial development. The results show that the intermediate regime induces higher and more volatile misalignment than both fixed and float. The fixed regime exhibits a pattern of misalignment similar to the float regime. Inflation pressures and dependence on oil exports are associated with more misalignment. More importantly, persistence in misalignment is an important phenomenon that should be taken into account, better quality of institutions is associated with less misalignment, while financial development seems to have no impact on misalignment.