Impact of Central Bank Intervention in the Foreign Exchange Market: Evidence from India Using an Event Study Approach

Abstract

The analysis of effectiveness of central bank intervention has yielded mixed empirical evidence and remains inconclusive to date. Managed float regimes can offer vital clues on this debate. We study the impact of central bank intervention on exchange rate direction, volatility and misalignment using data from the Indian managed float, characterised by consistent intervention by India's central bank. The paper uses event study methodology given the clustered and non‐stochastic nature of intervention. We find that direct intervention, through sale or purchase of foreign currency, is not successful in influencing the direction of exchange rate movement and does not have any statistically significant impact on volatility as corroborated by both monthly and daily data.

The Determinants of Exchange-Rate Volatility

“…Some documented bank intervention does not significantly determine the exchange-rate volatility [1], but there were some significant evidences that it determined the exchangerate volatility [2] and [3]. The Central Bank intervention efforts are intended to reduce the exchange-rate volatility of a currency [4], [5], but there are some documents that it actually increases the exchange-rate volatility [6]. Literature found that productivity determines the exchangerate volatility, but still empirically it proved different results.…”