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Can Higher Reserves Help Reduce Exchange Rate Volatility?

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Author Info

  • M. Nowak
  • Ketil Hviding
  • Luca Antonio Ricci

Abstract

This paper studies the role of an increase in foreign exchange reserves in reducing currency volatility for emerging market countries. The study employs a panel of 28 countries over the period 1986-2002. Several control variables are introduced in the regressions to account for other factors affecting exchange rate volatility (monetary and external indicators as well as conventional macroeconomic fundamentals). The paper controls for the endogeneity induced by the role of the exchange rate regime, since the regime can affect both the level of reserves and exchange rate volatility. The results provide ample support for the proposition that holding adequate reserves reduces exchange rate volatility. The effect is strong and robust; moreover, it is nonlinear and appears to operate through a signaling effect.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/189.

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Length: 32
Date of creation: 01 Oct 2004
Date of revision:
Handle: RePEc:imf:imfwpa:04/189

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Keywords: Exchange rate variability; Reserves adequacy; exchange rate; exchange rate volatility; effective exchange rate; exchange rate regime; real effective exchange rate; real exchange rate; foreign exchange; outliers; heteroscedasticity; standard deviation; statistics; real exchange rate volatility; exchange rate dummy; exchange rates; samples; exchange rate regimes; nominal exchange rate; fixed exchange rate; foreign exchange market; logarithm; probability; exchange market intervention; fixed exchange rate regimes; exchange restrictions; floating exchange rates; stochastic process; fixed exchange rate regime; flexible exchange rate; floating exchange rate regime; history of exchange rate; exchange rate dynamics; standard deviations; floating exchange rate; exchange rate indices; financial statistics; nominal effective exchange rate; freely floating exchange rates; autocorrelation; exchange rate fluctuations; current exchange rate; effective exchange rates; exchange arrangements; exchange reserves; time series; exchange markets; intermediate exchange rate regimes; correlation; surveys; exchange rate flexibility; empirical exercise; foreign exchange markets; intermediate exchange rate; bilateral exchange rate; linear model; functional form; exchange rate pass;

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References

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  1. Devereux, Michael B & Lane, Philip R., 2002. "Understanding Bilateral Exchange Rate Volatility," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3518, C.E.P.R. Discussion Papers.
  2. Caramazza, Francesco & Ricci, Luca & Salgado, Ranil, 2004. "International financial contagion in currency crises," Journal of International Money and Finance, Elsevier, Elsevier, vol. 23(1), pages 51-70, February.
  3. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  4. Roberto Rigobon, 2003. "Identification Through Heteroskedasticity," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 777-792, November.
  5. Ricardo Hausmann & Ugo Panizza & Ernesto H. Stein, 2000. "Why Do Countries Float the Way They Float?," Research Department Publications, Inter-American Development Bank, Research Department 4205, Inter-American Development Bank, Research Department.
  6. Andrew K. Rose, 1994. "Are exchange rates macroeconomic phenomena?," Economic Review, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, pages 19-30.
  7. Gordon M. Bodnar & Leonardo Bartolini, 1995. "Are Exchange Rates Excessively Volatile? and What Does "Excessively Volatile" Mean, Anyway?," IMF Working Papers 95/85, International Monetary Fund.
  8. Hasan, Shahriar & Wallace, Myles, 1996. "Real exchange rate volatility and exchange rate regimes: Evidence from long-term data," Economics Letters, Elsevier, Elsevier, vol. 52(1), pages 67-73, July.
  9. Reinhart, Carmen & Calvo, Guillermo, 2000. "When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options," MPRA Paper 6982, University Library of Munich, Germany.
  10. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  11. Jaewoo Lee, 2004. "Insurance Value of International Reserves," IMF Working Papers 04/175, International Monetary Fund.
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