Mwansa, Katwamba (2009): The Impact of Central Bank's intervention in the foreign exchange market on the Exchange Rate: The case of Zambia (1995-2008).
Download (982kB) | Preview
The central bank of Zambia called Bank of Zambia (BOZ) has, like many other central banks in both developing and developed economies, been from time to time intervening in the foreign exchange market by either purchasing or selling foreign exchange (mainly United States of America Dollars) to the market. Central banks have given a myriad of reasons for this particular behaviour. Chief among these and which is the focus of this paper is to smooth volatility or reverse a trend of the domestic currency in this case the kwacha. Despite central banks’ intervention activities in the foreign exchange markets, literature on the efficacy of these interventions in terms of impacting domestic currencies has remained controversial. While some strands of literature seem to suggest that such intervention has an impact on the currencies some literature disagrees.
Early studies done in the 1980s suggest that intervention operations do not affect the exchange rate and if they do this effect is very small and only in the short run. More recent studies however, have found evidence of the effect on both the level and volatility of exchange rates. Further, recent studies focused on emerging market and developing countries have found strong evidence of the effect of central banks’ intervention operations in the foreign exchange market on exchange rates.
This paper therefore examines the effect of the BOZ’s foreign currency market interventions on the level and volatility of the kwacha/ USD exchange rate between 1995 and 2008. In order to study the impact of interventions on the kwacha, the paper uses monthly data (both sales and purchases) on foreign exchange intervention and employs the GARCH (1, 1) and Exponential GARCH frameworks to model volatility. The results from GARCH model suggest that sales of foreign exchange in this case the $ causes the exchange rate to appreciate while purchases of the $ cause the exchange rate to depreciate. As for the impact on volatility, the GARCH (1, 1) model reveals that BOZ interventions increase volatility.
Empirical results from the EGARCH model on the other hand suggest that both sales and purchases of $ cause the exchange rate to appreciate. The results on the impact of intervention on volatility are mixed though generally intervention appears to be increasing volatility.
|Item Type:||MPRA Paper|
|Original Title:||The Impact of Central Bank's intervention in the foreign exchange market on the Exchange Rate: The case of Zambia (1995-2008)|
|Keywords:||foreign exchange intervention, Bank of Zambia, EGARCH|
|Subjects:||F - International Economics > F3 - International Finance > F31 - Foreign Exchange
A - General Economics and Teaching > A1 - General Economics > A10 - General
|Depositing User:||Katwamba Mwansa|
|Date Deposited:||04. May 2010 05:58|
|Last Modified:||01. Jan 2016 20:45|
Almekinders, G.J and Eijffinger, S.C.W.1994 The ineffectiveness of central Bank Intervention: CentER Discussion Paper Series. Tilburg University No 94101 pp1-18
Aguilar, J and Nydahl, S. 2000. Central Bank intervention and Exchange Rates: The case of Sweden. Journal of International Financial Markets, Institutions and Money 10 pp303-322
Aron, J and Eibadawi, I.A. 1992. Parallel Markets, the Foreign exchange Auction and Exchange rate Unification in Zambia. World Bank Working Paper WPS 909
Bacchetta, P and Van Wincoop, E. 2006. The American Economic Review Vol. 96 No3 pp552- 576
Bank for International Settlements (BIS). 2007. Foreign exchange and derivates market activity. Triennial Central Bank Survey.
Bank of Zambia, 2008. Annual Financial Reports
Beine, M. et al 2002. Central Bank Intervention and Foreign Exchange Rates: New evidence from FIGARCH estimations. Journal of International Money and Finance 21 pp 115-114.
Bordo, M and Scwartz, A. 1991. What has Foreign Exchange Market intervention since the Plaza Agreement accomplished? Open Economies Review 2. Pp39-64
Bonser- Neal, C. 1996. Does Central Bank intervention stabilize foreign exchange rates? Federal Reserve Bank of Kansas City.
Brooks , C. 2002. Introductory Econometrics for Finance. CUP Canales-Kriljenko, J.I.1995. Foreign exchange intervention in developing and transition economies: Results of a survey IMF Working Paper WP/03/95
Copeland, L .2008. Exchange Rates and International Finance (5th Edition). Prentice Hall Financial Times.
Disyatat, P and Galati, G 2005. The effectiveness of foreign Exchange intervention in emerging market countries: Evidence from the Czech Koruna. BIS Working Paper NO 172
Domac, I and Mendoza, A. 2004.Is there room for foreign exchange interventions under an inflation targeting framework? Evidence from Mexico and Turkey. World Bank Policy Research Working Paper 3288
Dominguez, K.M., 1998. Central Bank Intervention and Exchange rate Volatility. Journal of International Money and Finance, 17 161-190.
Dominguez, K.M. 1990 Market Responses to coordinated central bank intervention. Carnegie –Rochester Conference Series on Public Policy 32 pp 121-164
Dominguez, K.M. 2006. When do Central Bank Intervention Influence intra-daily and longer -term exchange rate movements. Journal of International Money and Finance 25 pp 1051-1071
Dominguez, K.M. 2003. The Market Microstructure of Central Bank Intervention. Journal of International Economics 59 pp 25-45
Dominguez, K.M. 2003. Foreign Exchange Intervention: Did it work in the 1990s. Institute of International Economics
Dominguez,K.M and Frankel, J.A. 1993A. Does Foreign Exchange Intervention work? Washington D.C. Institute of International Economics
Dominguez,K.M and Frankel, J.A. 1993B. Does Foreign Exchange Intervention Matter? The Portfolio Effect. American Economic Review vol 83 No 5 pp 1356-1369
Enders, W. 2004. Applied Econometric Time Series ( 2nd Edition) John Wiley & Sons Inc
Edison, H., Cashin, P. & Liang, H., 2003. Foreign exchange intervention and the Australian Dollar: Has it mattered? IMF Working paper WP/03/99.
Fatum, R. and Hutchison, M., 1999B. Is sterilized foreign exchange intervention effective after all: An event study approach?
Fatum, R and Hutchison, M. 1999A. Is intervention a signal of future monetary policy? Evidence from the Federal Funds Futures Market. Journal of Money, Credit and Banking Vol 31 No1 pp 54-69.
Frenkel, M et al 2005. The effects of Japanese foreign exchange market intervention on the Yen/US Dollar exchange rate volatility. International Review of Economics and Finance No 14 page 27-39
Ghosh, A.R. 1992. Is it signalling? Exchange Intervention and the dollar- Deutschemark Rate. Journal of International Economics 32 pp 201-220 North –Holland.
Hallwood,C.P and MacDonald, R. 3rd edition International Money and Finance Blackwell Publishers.
Hardy, D.C, 1997. Market information and signaling in central bank operations or how often should a central bank intervene? IMF Working Paper 28
Humpage, O.F. 1999. US Intervention: Assessing the probability of success. Journal of Money, Credit and Banking. Volume 31 No 4 pp731-747
Hoshikawa, T. 2008. The causal relationship between foreign exchange Intervention and exchange rate. Applied economics letters. London Vol. 15 Iss.7
Hoshikawa, T 2008. The effect on intervention frequency on the foreign Exchange market: The Japanese experience. Journal of International Money and Finance Vol.27 Iss. 4 p 547.
IMF country Report. 2008. No 08/187 Washington. D.C.
Kaminsky, G.L and Lewis, K.K. 1996. Does foreign Exchange Intervention signal monetary policy. Journal of Monetary Economics 37 pp 285-312.
Kaminsky, G. and Lewis, K. 1996. Does Foreign Exchange Intervention Signal future monetary policy? Journal of Monetary Economics 37 285- 312.
Kim, S et al. 2000. Central Bank intervention and exchange rate volatility – Australian Evidence. Journal of International and Financial Markets Institutions and Money 10(210) pp381-405.
Loopsesko, B.E. 1984. Relationships among Exchange Rate intervention and interest rates: An empirical investigation. Journal of International Money and Finance 3(3) pp 257-77
Mussa, M 1981. The Role of Official Intervention. Group of Thirty New York
Neely, C.J. 2000. The practice of central bank intervention: Looking around the Hood .The Federal Reserve Bank of St. Louis Working Paper Series 28
Neely, C. 2005. An analysis of Recent studies of the effect of foreign exchange intervention. Federal Reserve Bank of St. Louis Review 87(6) pp 685-717
Pilbeam, K 2006. International Finance (3rd edition).Palgrave Macmillan
Sarantis, N., 2006. On the short-term predictability of exchange rates: A BVAR time-varying parameters approach. Journal of Banking and Finance 30, 2257-2279
Sarno, L and Taylor, M.P. 2001. Official intervention in the Foreign Exchange Market: Is it effective and if so how does it work? Journal of Economic Literature. Vol 39 N0 3 PP 839-868
Sarno, L and Taylor, M.P. 2008. The Economics of Exchange Rates. Cambridge University Press. Cambridge
Simatachela, M. 2004. Financial Sector Reforms and Monetary Policy in Zambia. PhD dissertation Department of Economics Goteborg University- Sweden.