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Does Foreign Exchange Reserve Decumulation Lead to Currency Appreciation?

Author

Listed:
  • Kathryn M.E. Dominguez

    (Gerald R. Ford School of Public Policy, University of Michigan)

  • Rasmus Fatum

    (School of Business, University of Alberta)

  • Pavel Vacek

    (School of Business, University of Alberta)

Abstract

Many developing countries have increased their foreign reserve stocks dramatically in recent years, often motivated by the desire for precautionary self-insurance. One of the negative consequences of large accumulations for these countries is the risk of valuation losses. In this paper we examine the implications of systematic reserve decumulation by the Czech authorities aimed at mitigating valuation losses on euro-denominated assets. The policy was explicitly not intended to influence the value of the koruna relative to the euro. Initially the timing and size of reserve sales was not predictable, eventually sales occurred on a daily basis (in three equal installments within the day). This project examines whether these reserve sales, both during the regime of discretionary timing as well as when sales occurred every day, had unintended consequences for the domestic currency. Our findings using intraday exchange rate data and time-stamped reserve sales indicate that when decumulation occurred every day these sales led to significant appreciation of the koruna. Overall, our results suggest that the manner in which reserve sales are carried out matters for whether reserve decumulation influences the relative value of the domestic currency.

Suggested Citation

  • Kathryn M.E. Dominguez & Rasmus Fatum & Pavel Vacek, 2010. "Does Foreign Exchange Reserve Decumulation Lead to Currency Appreciation?," EPRU Working Paper Series 2010-06, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  • Handle: RePEc:kud:epruwp:10-06
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    References listed on IDEAS

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    Cited by:

    1. Dominguez, Kathryn M.E. & Hashimoto, Yuko & Ito, Takatoshi, 2012. "International reserves and the global financial crisis," Journal of International Economics, Elsevier, vol. 88(2), pages 388-406.
    2. Dominguez, Kathryn M.E., 2012. "Foreign reserve management during the global financial crisis," Journal of International Money and Finance, Elsevier, vol. 31(8), pages 2017-2037.
    3. Lubomír Lízal & Jirí Schwarz, 2013. "Foreign exchange interventions as an (un)conventional monetary policy tool," BIS Papers chapters,in: Bank for International Settlements (ed.), Sovereign risk: a world without risk-free assets?, volume 73, pages 127-143 Bank for International Settlements.

    More about this item

    Keywords

    foreign exchange reserves; exchange rate determination; high-frequency volatility modeling;

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F55 - International Economics - - International Relations, National Security, and International Political Economy - - - International Institutional Arrangements

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