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Capital Inflows and Exchange Rate Volatility in Korea

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  • Kyuil Chung

    (The Bank of Korea)

Abstract

High exchange rate volatility threatens international trade and exacerbates the currency mismatch problem, hence generating economic instability. However, low exchange rate volatility may cause another problem. Low volatility induces speculative capital inflows as speculative investors, who are usually concerned both with the interest rate differential and exchange rate risk, become concerned with the interest rate differential only. In this paper we use several techniques to identify the relationship between exchange rate volatility and capital inflows in Korea. First, estimation of a Markov switching model shows that all kind of capital inflows increase under low volatility regimes, while capital inflows with the exception of FDI all decrease under high volatility regimes. Second, estimation of a multivariate GARCH-in-Mean Model and the impulse response function derived from it provide evidence that lower exchange rate volatility tends to increase most types of capital inflows other than FDI. These results imply that a medium level of exchange rate volatility is most beneficial for economic stability

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  • Kyuil Chung, 2013. "Capital Inflows and Exchange Rate Volatility in Korea," 2013 Meeting Papers 890, Society for Economic Dynamics.
  • Handle: RePEc:red:sed013:890
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    References listed on IDEAS

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    1. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1996. "Inflows of Capital to Developing Countries in the 1990s," Journal of Economic Perspectives, American Economic Association, vol. 10(2), pages 123-139, Spring.
    2. Edwards, Sebastian & Rigobon, Roberto, 2009. "Capital controls on inflows, exchange rate volatility and external vulnerability," Journal of International Economics, Elsevier, vol. 78(2), pages 256-267, July.
    3. Fratzscher, Marcel, 2012. "Capital flows, push versus pull factors and the global financial crisis," Journal of International Economics, Elsevier, vol. 88(2), pages 341-356.
    4. Cushman, David O., 1983. "The effects of real exchange rate risk on international trade," Journal of International Economics, Elsevier, vol. 15(1-2), pages 45-63, August.
    5. Apostolos Serletis, 2012. "Oil Price Uncertainty," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 8407, December.
    6. Chowdhury, Abdur R, 1993. "Does Exchange Rate Volatility Depress Trade Flows? Evidence from Error-Correction Models," The Review of Economics and Statistics, MIT Press, vol. 75(4), pages 700-706, November.
    7. Kroner, Kenneth F. & Lastrapes, William D., 1993. "The impact of exchange rate volatility on international trade: Reduced form estimates using the GARCH-in-mean model," Journal of International Money and Finance, Elsevier, vol. 12(3), pages 298-318, June.
    8. Elder, John, 2003. "An impulse-response function for a vector autoregression with multivariate GARCH-in-mean," Economics Letters, Elsevier, vol. 79(1), pages 21-26, April.
    9. Elder, John, 2004. "Another Perspective on the Effects of Inflation Uncertainty," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(5), pages 911-928, October.
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