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Central bank intervention and exchange rate volatility in Pakistan: an analysis using GARCH-X model

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  • Muhammad Kashif Ali Shah
  • Zulfiqar Hyder
  • Muhammad Khalid Pervaiz

Abstract

Excessive exchange rate volatility has a deleterious effect on international financial flows, external trade, investment and output. Among others, these economic costs prompt the central bank in emerging countries to contain excessive exchange rate volatility through intervention in the foreign exchange market. This article investigates the effectiveness of State Bank of Pakistan's (SBP) daily foreign exchange intervention starting from 3 July 2000 to 31 December 2005 (1593 trading day observations). The method of Generalized Autoregressive Conditional Heteroscedasticity, with exogenous variables (GARCH-X), used in this article, shows that SBP's intervention operation is very effective as it not only affects the exchange rate levels but also reduces the exchange rate volatility. It is also found that the short-term interest rate and the size of the foreign exchange reserves held by SBP also affect the exchange rate level and its volatility. Increase in short-term interest rate and higher foreign exchange reserves are associated with appreciation of exchange rate levels and vice versa. In addition, higher foreign exchange reserves also reduce the exchange rate volatility. In sharp contrast to the no days-of-the-week effects on exchange rate level, the results show that there is some evidence of significant days-of-the-week effects of intervention on exchange rate volatility.

Suggested Citation

  • Muhammad Kashif Ali Shah & Zulfiqar Hyder & Muhammad Khalid Pervaiz, 2009. "Central bank intervention and exchange rate volatility in Pakistan: an analysis using GARCH-X model," Applied Financial Economics, Taylor & Francis Journals, vol. 19(18), pages 1497-1508.
    • Handle: RePEc:taf:apfiec:v:19:y:2009:i:18:p:1497-1508
    DOI: 10.1080/09603100902967553
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    References listed on IDEAS

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    Cited by:

    1. Munazza Jabeen & Saud Ahmad Khan, 2014. "Modelling Exchange Rate Volatility by Macroeconomic Fundamentals in Pakistan," International Econometric Review (IER), Econometric Research Association, vol. 6(2), pages 58-76, September.
    2. Koji Kubo, 2017. "Impacts of Foreign Exchange Auctions on the Informal Market Rate in Myanmar," Global Economic Review, Taylor & Francis Journals, vol. 46(2), pages 189-202, April.
    3. Gnagne, Pascal Xavier & Bonga-Bonga, Lumengo, 2020. "The Impact of Exchange Rate Volatility on the Security Markets in BRICS Economies," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 73(1), pages 21-50.
    4. Muteba Mwamba, John & Dube, Sandile, 2014. "The impact of exchange rate volatility on international trade between South Africa, China and USA: The case of the manufacturing sector," MPRA Paper 64389, University Library of Munich, Germany.
    5. Li, He & Zhang, Zhichao & Zhang, Chuanjie, 2017. "China’s intervention in the central parity rate: A Bayesian Tobit analysis," Research in International Business and Finance, Elsevier, vol. 39(PA), pages 612-624.
    6. Bonga-Bonga, Lumengo & Gnagne, Pascal Xavier, 2017. "The impact of exchange rate volatility on capital flows in BRICS economies," MPRA Paper 84773, University Library of Munich, Germany.
    7. repec:erh:journl:v:6:y:2014:i:2:p:59-77 is not listed on IDEAS
    8. Yutaka Kurihara, 2018. "Occurred Uncertainty by ‘News’ in Japanese Short- and Long-Term Financial Markets," International Journal of Economics and Financial Research, Academic Research Publishing Group, vol. 4(4), pages 93-98, 04-2018.
    9. Corbet, Shaen & Larkin, Charles & McMullan, Caroline, 2018. "Chemical industry disasters and the sectoral transmission of financial market contagion," Research in International Business and Finance, Elsevier, vol. 46(C), pages 490-501.

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