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Relationship between Exchange Rate Volatility and Central Bank Intervention

Author

Listed:
  • Harendra Behera

    (Harendra Behera is with the Department of Economic Analysis and Policy, Reserve Bank of India, Sahid Bhagat Singh Road, Mumbai-400 001, India. Email: hbehera@rbi.org.in)

  • Vathsala Narasimhan
  • K.N. Murty

    (Vathsala Narasimhan and K.N. Murty are with the Department of Economics, University of Hyderabad, Hyderabad-500046, India. Email: vnss@uohyd.ernet.in and knmss@uohyd.ernet.in)

Abstract

In a world of high capital mobility, several risks are emerging in the financial markets and the Central Bank intervention has played an important role in managing these risks. In India, the Reserve Bank of India (RBI) intervenes in the foreign exchange market to maintain orderly market conditions. This article empirically explores the relationship between Central Bank intervention and exchange rate behaviour in the Indian foreign exchange market. Specifically, the article investigates the effects of RBI intervention on exchange rate level and volatility. Using monthly data for April 1995 through December 2006 and GARCH (1,1) model, it is found that the intervention of the RBI is effective in reducing volatility in the Indian foreign exchange market instead of reversing trend movement of exchange rate. It is also observed that FII investments increase exchange rate volatility in India.

Suggested Citation

  • Harendra Behera & Vathsala Narasimhan & K.N. Murty, 2008. "Relationship between Exchange Rate Volatility and Central Bank Intervention," South Asia Economic Journal, Institute of Policy Studies of Sri Lanka, vol. 9(1), pages 69-84, June.
  • Handle: RePEc:sae:soueco:v:9:y:2008:i:1:p:69-84
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    Keywords

    JEL: F31; JEL: C22; JEL: G21; Exchange Rate; GARCH; Central Bank Intervention;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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