Capital Control, Speculation and Exchange Rate Volatility

Mei-Lie Chu

No 652, Econometric Society 2004 Far Eastern Meetings from Econometric Society

Abstract: This paper studies a plausible connection among rational speculators, exchange rate volatility and capital controls. When Krugman (1999) asserted that there should be appropriate controls on international capital movements to avoid currency volatilities from speculative activities, this paper shows whether to take capital controls depends on types of shocks and the risk preference of rational speculators. (1)If only current account shocks occur, the increase in the risk preference of rational speculators will decrease the conditional variance of exchange rates. In this case, the best policy is to let capitals freely move in the world. (2)If only interest rate shocks occur, the conditional variance of the exchange rate is monotonically increasing in the risk preference of rational speculators. Under such circumstance, the controls over international capital movements indeed decrease the exchange rate volatility. (3)When both current account and capital account shocks occur, then, if speculators are more risky, capital controls decrease exchange-rate volatility; however, if speculators are less risky, free capital movements can temper the exchange rates response to transitory shocks

Keywords: Capital Controls; Speculation; Exchange Rate Volatility (search for similar items in EconPapers)
JEL-codes: F32 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-ifn
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Citations: View citations in EconPapers (1)

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