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

48 Pages Posted: 9 Apr 2013

See all articles by Marius Rodriguez

Marius Rodriguez

Board of Governors of the Federal Reserve System

Thomas Wu

University of California, Santa Cruz - Department of Economics

Date Written: March 8, 2013

Abstract

Has the recent wave of capital controls and prudential FX measures been effective in promoting exchange rate stability? We tackle this question by studying a panel of 25 countries/currencies from July 1st , 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 in which policy changes are implemented. Using a difference-in-differences approach, we find evidence that: (i) exchange rate stability gains from the tightening of controls on nonresidents are illusive, the suppression of daily exchange rate ‡fluctuations comes at the cost of increasing likelihood of currency crisis, with no clear benefits for absolute crash risk; (ii) the easing of controls on residents truly improves exchange rate stability over all dimensions; and (iii) the tightening prudential FX measures not specific to derivative markets reduces absolute crash risk and tail risk, with no effect on volatility.

Keywords: Exchange Rates, Volatility, Crash and Tail Risk, Currency Options, Capital Controls, Prudential Measures

Suggested Citation

Rodriguez, Marius and Wu, Thomas, The Effect of Capital Controls and Prudential FX Measures on Options-Implied Exchange Rate Stability (March 8, 2013). Available at SSRN: https://ssrn.com/abstract=2246872 or http://dx.doi.org/10.2139/ssrn.2246872

Marius Rodriguez (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

Thomas Wu

University of California, Santa Cruz - Department of Economics ( email )

Santa Cruz, CA 95064
United States
831-459-4453 (Phone)
931-459-5077 (Fax)

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