Can Higher Reserves Help Reduce Exchange Rate Volatility?

Author/Editor:

M. Nowak ; Ketil Hviding ; Luca A Ricci

Publication Date:

October 1, 2004

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

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.

Series:

Working Paper No. 2004/189

Subject:

Emerging and frontier financial markets Exchange rate arrangements Exchange rates Real effective exchange rates Real exchange rates

English

Publication Date:

October 1, 2004

ISBN/ISSN:

9781451859645/1018-5941

Stock No:

WPIEA1892004

Pages:

32

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