Foreign Exchange Market Intervention and Exchange Rate Volatility: A Bivariate GARCH Model for India

Linkon Mondal

The IUP Journal of Bank Management, 2012, vol. XI, issue 4, 29-40

Abstract: The present study attempts to investigate the effectiveness of the Reserve Bank of India’s (RBI) intervention policy in the foreign exchange market and tries to capture the volatility spillover between intervention and exchange rate. The evidence derived from the estimated model indicates that the RBI leans against the wind in response to appreciating and depreciating pressure on rupee; hence, there is no evidence of any asymmetry in intervention. Good news has significant negative impact on exchange rate as it tends to put pressure on exchange rate to appreciate. However, intervention operations reduce exchange rate volatility, whereas news seems to trigger exchange rate volatility. The significant coefficient with respect to volatility spillover shows the existence of volatility transmission from the RBI’s intervention to exchange rate and vice versa. The significant coefficient of the past volatility of intervention implies that the past volatility of intervention has a positive impact on present volatility of exchange rate. Similarly, the past volatility of exchange rate increases the present volatility of intervention. The volatility of the exchange rate seems to be more sensitive to its past shock than the past shock of intervention, and the volatility of intervention is more sensitive to the past volatility of exchange rate as compared to the past volatility of intervention.

Date: 2012
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