Effect of foreign exchange intervention: The case of Korea

Abstract

Using a rolling-window approach that allows time-varying coefficients, we estimate the vector autoregressive model with the Markov chain Monte Carlo method to analyse the effectiveness of foreign exchange interventions in Korea. Our results show that a negative shock in international reserves (buying domestic currency or selling foreign currency) results in a significant appreciation of the domestic currency, a reduction in implied volatility and an increase in capital inflows. We also find that Korean exchange rate policies focus on the stabilization of the foreign exchange market rather than the depreciation of the Korean won. These patterns appear more obvious after the 2008 global financial crisis. This suggests that time variation should be taken into account to better understand the effects of foreign exchange interventions.