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South Asia Economic Journal
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Research Articles

Relationship between Exchange Rate Volatility and Central Bank Intervention

An Empirical Analysis for India

Harendra Behera

Harendra Behera is with the Department of Economic Analysis and Policy, Reserve Bank of India, Sahid Bhagat Singh Road, Mumbai-400 001, India. Email: hbehera{at}rbi.org.in

Vathsala Narasimhan

K.N. Murty

Vathsala Narasimhan and K.N. Murty are with the Department of Economics, University of Hyderabad, Hyderabad-500046, India. Email: vnss{at}uohyd.ernet.in and knmss{at}uohyd.ernet.in

In a world of high capital mobility, several risks are emerging in the financial markets and the Central Bank intervention has played an important role in managing these risks. In India, the Reserve Bank of India (RBI) intervenes in the foreign exchange market to maintain orderly market conditions. This article empirically explores the relationship between Central Bank intervention and exchange rate behaviour in the Indian foreign exchange market. Specifically, the article investigates the effects of RBI intervention on exchange rate level and volatility. Using monthly data for April 1995 through December 2006 and GARCH (1,1) model, it is found that the intervention of the RBI is effective in reducing volatility in the Indian foreign exchange market instead of reversing trend movement of exchange rate. It is also observed that FII investments increase exchange rate volatility in India.

Key Words: JEL: F31 • JEL: C22 • JEL: G21 • Exchange Rate • GARCH • Central Bank Intervention

South Asia Economic Journal, Vol. 9, No. 1, 69-84 (2008)
DOI: 10.1177/139156140700900103
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