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2022 | OriginalPaper | Buchkapitel

Official Interventions in the Foreign Exchange Market: Implications for Exchange Rate and Its Volatility

verfasst von : Hersch Sahay, M. Ramachandran

Erschienen in: Studies in International Economics and Finance

Verlag: Springer Singapore

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Abstract

The official interventions undertaken by monetary authorities in the foreign exchange markets are largely aimed at minimizing the volatility of exchange rates. However, these interventions as documented in literature are more of the type of ‘secret interventions’ which are likely to create ambiguity in the market and trigger volatility. We examine this issue using monthly data from a sample of nine countries for the period 1997:01 to 2019:12. The empirical evidence obtained from GARCH estimates of a dynamic panel model with conditional covariance as proposed by Cermeño and Grier (Contributions to economic analysis. Elsevier, pp. 259–277, 2006) reveals that official intervention is counterproductive, i.e. such interventions seem to trigger the volatility of exchange rates rather than minimizing them.

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The literature on official interventions contains two differing opinions on defining intervention: one with a ‘narrow’ approach and the other which adopts a ‘broad definition’. Please refer to Moreno (2005) for an in-depth understanding of these definitions. For all practical purposes, we adopt the broad definition of official intervention in this paper which defines official intervention as ‘any sale or purchase of foreign exchange against domestic currency which monetary authorities undertake in the exchange market’ (Jurgensen, 1983).

Most of the respondents of the series of surveys conducted by Bank of International Settlement (BIS) in 2005, 2013 and 2019 for central banks reported that one of the immediate objectives of their intervention operations in the foreign exchange market is to moderate exchange rate volatility.

An important prerequisite of panel GARCH models is that the panel is balanced, i.e. each cross section contains the same number of time period observations.

For instance, Kiviet (1995) points to the fact that LSDV estimators are downward biased in dynamic panel models with fixed effects and iid errors when the sample has small \(T\).

Given this restriction on the number of cross sections apart from the fact that \({\varvec{T}}\) has be sufficiently large as compared to \({\varvec{N}}\) (Cermeño & Grier, 2006), we tried to choose a sample period which will have the maximum possible \({\varvec{T}}\). Moreover, we could not account for structural breaks in the model because different countries may have different break dates and accounting for all those breaks would increase the number of parameters to be estimated. This was also the reason for choosing December 2019 as the end of our sample in order to avoid distortions in results arising from the ongoing COVID-19 pandemic crisis.

Measured in US dollars.

This is in accordance with the broad definition of official intervention that we have adopted in this study as noted in Footnote 1.

\({\tilde{e }}_{t}= \frac{{e}_{t}-{e}_{t-1}}{{e}_{t-1}}\times 100\).

It is cautioned that the LSDV provides best linear estimators if and only if the assumption of cross-sectional independency and identical variance across cross-sectional units is valid.

Cermeño and Grier (2006) have also followed a similar strategy for specifying the mean equation.

In this model, we do not estimate the covariance equation based on the assumption of cross-sectional independence, i.e., the model consists of only Eqs. (8) and (9).

The likelihood ratio statistic is defined as follows: \({\text{LR}} = 2 \times \ln \left( {\frac{{\text{Log likelihood of unrestrcited model}}}{{\text{Log likelihood of restricted model}}}} \right)\sim \chi_{\left( q \right)}^{2}\), where \(q\) is the number of restrictions in the restricted model.

In this case, we specify Eq. (10) with a common intercept assuming no cross-sectional fixed effects.

Nonetheless, a recent work by Daude et al. (2016) concludes that based on the available literature, a systematic and significant link between exchange rate interventions and their anticipated effect on exchange rates has not been established. Further, they also argue that in most cases, the link seems insignificant or appear with the ‘wrong’ sign.

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Titel: Official Interventions in the Foreign Exchange Market: Implications for Exchange Rate and Its Volatility
verfasst von: Hersch Sahay
M. Ramachandran
Verlag: Springer Singapore
Buch: Studies in International Economics and Finance
Print ISBN: 978-981-16-7061-9

Electronic ISBN: 978-981-16-7062-6

Copyright-Jahr: 2022
DOI: https://doi.org/10.1007/978-981-16-7062-6_27

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