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Can Higher Reserves Help Reduce Exchange Rate Volatility?

Author/Editor: Hviding, Ketil | Nowak, M. | Ricci, Luca Antonio
Authorized for Distribution: October 1, 2004
Electronic Access: Free Full Text (PDF file size is 421KB)
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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. 04/189
Subject(s): Exchange rate variability | Reserves | Reserves adequacy
Author's keyword(s): Foreign exchange volatility | reserves | reserve adequacy
 
English  
    Published:   October 1, 2004        
    ISBN/ISSN:   1934-7073   Format:   Paper
    Stock No:   WPIEA1892004   Pages:   32
    Price:   US$15.00
       
     
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