Working Paper

The Effect of Capital Controls and Prudential FX Measures on Options-Implied Exchange Rate Stability

Abstract: Has the recent wave of capital controls and prudential foreign exchange (FX) measures been effective in promoting exchange rate stability? We tackle this question by studying a panel of 25 countries/currencies from July 1, 2009, to June 30, 2011. We calculate daily measures of exchange rate volatility, absolute crash risk, and tail risk implied in currency option prices, and we construct indices of capital controls and prudential FX measures taking into account the exact date when policy changes are implemented. Using a difference-in-differences approach, we find evidence that (i) tightening controls on non-residents suppresses daily exchange rate fluctuations at the cost of increasing the frequency of outliers, (ii) easing controls on residents truly improves exchange rate stability over all dimensions, and (iii) tightening prudential FX measures not specific to derivative markets reduces absolute crash risk and tail risk, with no effect on volatility.

Keywords: Foreign; exchange;

https://doi.org/10.24148/wp2013-20

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2013-05-01

Number: 2013-20

Pages: 50 pages