signaling hypothesis

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FOREIGN EXCHANGE INTERVENTION AND FUTUREMONETARY POLICY: SOME EMPIRICAL EVIDENCE

ON SIGNALING HYPOTHESIS

K.G. Sahadevan, Ph.DAssociate Professor

Indian Institute of ManagementPrabandh Nagar, Off Sitapur Road

Lucknow 226 013INDIA

E-mail: [email protected]: 0522-361889

Fax: 0522-361840


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FOREIGN EXCHANGE INTERVENTION AND FUTURE

MONETARY POLICY: SOME EMPIRICAL EVIDENCEON SIGNALING HYPOTHESIS

*

ABSTRACT

The present study attempts to examine the following questions in the Indian context. Has foreign

exchange intervention been successful in stabilizing exchange rate? Has the intervention been

sterilized with the objective of maintaining monetary target? Does intervention signal changes infuture monetary policy variables? The estimates of the intervention and sterilization equationsindicate that the central bank sterilizes a major portion of reserve flow, and purchases US$ when

its price in terms of rupee is low and vice versa. The estimates of the money supply process show

that purchases (sale) of US$ are correlated with expansionary (contractionary) monetary policyin the future. However, the results from Granger test of causality indicate that intervention does

not have any significant causal relationship with monetary variable and exchange rate.

Keywords: Exchange rate; Central Bank Intervention; Monetary Policy

JEL Classification: F31; E58


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The non-sterilized interventions, on the other hand, change the monetary aggregates and

interest rates due to which exchange rates would be affected in the same way as the

domestic open market operations do. The signaling hypothesis proposed by Mussa

(1981) has given a new dimension to this issue triggering voluminous research in recent

times. It says that foreign exchange intervention is an effective and predictable signal of

monetary policy actions. He has argued that interventions induce traders in the market to

alter their expectations of future monetary policy or long-run equilibrium value of the

exchange rate. When the market revises its expectations of future money supplies, it also

revises its expectations of the future spot exchange rate, which in turn brings about a

change in the current rate. In this theoretical setting the present paper seeks to answer the

following questions empirically. Has foreign exchange intervention been successful in

stabilizing exchange rate? Has the intervention been sterilized with the objective of

maintaining monetary target? Does intervention signal changes in future monetary policy

variables? These questions have been examined empirically in the Indian context using

monthly data on Reserve Bank of Indias (RBI) foreign exchange intervention from June

1995 through May 2001.

The remainder of the paper is organized into four sections. Section II briefly reviews the

literature on the effectiveness of foreign exchange intervention. Section III carries a

description on the international perspective of nature and purpose of intervention. The

formulation of testable hypothesis and the equations for estimation have been discussed

in section IV and section V presents results of the study and discussion. Section VI

concludes the findings of the study. A description on data and variables, and

methodology of the study has been presented as appendix.

II. REVIEW OF PREVIOUS STUDIES

There is extensive literature on the effect of foreign exchange market intervention on

exchange rate and future monetary policy variables.2 However, there has been very little

evidence to suggest that intervention consistently and directly affects spot exchange rates,

through either monetary, or a portfolio balance transmission channel [Baillie., et al,


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(2000)].3 Most of the studies in this area are in the US context and are concerned with

the effect of intervention on the US$ exchange rates against Japanese Yen and German

Mark. These Studies differ in the methodologies used. Three different methodologies

have been utilized for empirical investigation. First, there are attempts to measure the

effect of current intervention on the exchange rate over and above the contribution of the

current fundamental. Secondly, the most common method has been the estimation of

money supply process (equation 2 below) and measurement of the ability of intervention

to predict the future course of money supply. The third approach, which has been used in

Fatum and Hutchison (1999), is to directly estimate the effect of intervention on changes

in expected monetary policy.

The findings of Dominguez and Frankel (1993) have supported the effect of Federal

Reserve and Bundesbank intervention on exchange rate through the portfolio channel as

against the consensus view thus far that the portfolio channel of intervention had been

ineffective. Similarly, the findings of Ramaswamy and Samiei (2000) on the basis of a

simple forward looking model of the exchange rate showed that interventions conducted

during 1995-99 succeeded in changing the path of the yen-dollar rate in the desired

direction. The results from probit model indicated that the Bank of Japan (BoJ) had

pursued a symmetrical policy by which both an excessive appreciation and depreciation

of the yen provoked interventions, and that interventions in the yen-dollar market tend to

occur in clusters. In the context of UK, Kearney and MacDonald (1986) have examined

the potency of sterilized intervention using a portfolio balance model the result of which

indicated that sterilized intervention had been effective on British pound-US$ exchange

rates.

The evidences from most of the studies are in favor of signaling channel, which reveals

the monetary policy intentions of the central bank through interventions. The portfolio

channel through which sterilized intervention affect exchange rates, on the other hand,

has received little empirical support. Using bivariate vector autoregressions and Granger-

causality tests, Lewis (1995) has examined whether intervention helps predict future

changes in monetary policy in the US context. The study reports a mixed picture of the


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signaling story and finds a circular relationship between intervention and future monetary

policy. Kaminsky and Lewis (1996) have also reported similar results, which indicate

that the US intervention provided a signal to future changes in interbank rates and

monetary aggregates, but sometimes in the opposite direction of that predicted by the

conventional signaling hypothesis. Ghose (1992) tested the portfolio balance channel by

examining the effects of changes in relative asset supplies on the US$-Deutschemark rate

and found a weak, but statistically significant, portfolio balance influence on the

exchange rate. In Fatum and Hutchison (1999), the evidence obtained from GARCH

model found dollar intervention not related to a rise in expected future short-term interest

rates (monetary tightening). They have used the federal funds futures market prices as

the proxy for market expectations on future monetary policy.

Over the past few years, attention has been shifted to studying the effect of intervention

on exchange rate volatility. On the whole, the evidence from these studies on impact of

intervention on conditional exchange rate volatility as well as on implied volatility is not

very conclusive. Aguilar and Nydahl (2000) reported results from GARCH models that

central banks sterilized intervention has not systematically reduced the volatility of

Swedish kroner rates against US$ and Deutsch Mark. The evidence presented in Bonser-

Neal (1996) on the Federal Reserves intervention suggested that the central bank

intervention had little effect on volatility. Using the Friedmans profit test4Andrew

and Broadbent (1994) tested the effectiveness of the Reserve Bank of Australias (RBA)

intervention and showed that RBA has made significant profits from intervention and that

intervention has tended to stabilize the Australian dollar exchange rate over the period the

currency has been floating. The nonavailability of data on the rate and volume of intra-

day sale and purchase of foreign currency undertaken by any central bank however limit

the feasibility of profit test. The study has also used the Wonnacotts criterion5the result

of which supported the findings of profit test. Kim et al (2000) came out with similar

evidence in the Australian context by showing that sustained and large interventions have

a stabilizing influence in the Australian $-US$ market in terms of direction and volatility

during 1983-97. Galati and Melick (1999) studied the impact of the Federal Reserves

and BoJs intervention on the instantaneous and expected volatility (derived from option


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prices) of yen-US$ exchange rates and found that the interventions did not have any

impact on the forward rates but suggested that it could increase the uncertainty in the

movement of spot rates. However, Baillie and Osterberg (1997) found some evidence

that intervention leads to increases in volatility and also influences the risk premium in

the Deutschemark-US$ and Yen-US$ forward markets. They have also reported that

intervention is Granger caused by high volatility of changes in the nominal exchange rate

and unidirectional from intervention to risk in the forward market. They have concluded

that intervention is motivated by increases in spot rather than forward market volatility.

To conclude, there is no general consensus evidence to support the portfolio balance

channel. However, there is some, but no conclusive evidence that intervention mainly

works through the signaling channel, i.e., by the central bank conveying a signal to

market participants about information on future fundamentals that they do not have. In a

fairly comprehensive survey of research Baillie et al (2000) concluded that empirical

work to date suggests that exchange market intervention does not directly affect the

fundamental economic determinants of exchange rates, but allows for the possibility that

intervention may sometimes influence market expectations about those fundamentals.

III. INTERVENTION UNDER FLOATING SYSTEM

In its true sense, no currencies in the world are freely floated. Since the beginning of

floating exchange rate system in 1973, most of the worlds major central banks have

intervened frequently and at times forcefully in the foreign exchange markets to influence

the path that their respective currencies have taken. Although there are no well defined

rules governing the motive of intervention, the IMFs Principles for the Guidance of

Members Exchange Rate Policies describes that a member should intervene in the

exchange market if necessary to counter disorderly conditions which may be

characterized inter aliaby disruptive short-term movements in the exchange value of its

currency. In the Indian context, in addition to the trade and capital controls imposed by

the government, the Reserve Bank of India (RBI) uses its foreign exchange reserves for

market intervention so as to align the market rate of rupee with its desiredrate consistent


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with certain macroeconomic parameters. This official exchange rate management has a

conventional objective of ensuring the currency not deviating far away from the long-run

equilibrium rate. However, other considerations like maintaining export competitiveness,

guarding currency against speculation, etc., often outweigh this objective and necessitate

official intervention to lean against the wind of short-term exchange rate movements.

Though the direct intervention alters the demand and supply forces in the market which,

lead to correction in exchange rates in the short-term, its effectiveness however depends

on the volume of intervention relative to the daily turnover in the market. The market

intervention has various implications, and it is designed to fulfill certain intentions of the

central bank depending on the choice between sterilized intervention and non-sterilized

intervention. The sterilized intervention through open market operations offsets the

change in net foreign assets by a corresponding change in net domestic assets. This in

turn helps the central bank to adhere to monetary targets. RBI at times resorts to

sterilized intervention not essentially to directly affect exchange rate but to give signal in

two counts. First, it signals the intention of the central bank to control the monetary

growth and secondly, it signals the undesirable changes in exchange rate that are being

taken place in the marketplace. These signals eventually force traders with vulnerable

long or short positions to abort speculation and bring exchange rate in alignment with its

long-run trend rate or to maintain the rates at a desired level. The non-sterilized

intervention, on the other hand, creates a mismatch between supply of and demand for

money eventually leading to change in exchange rate in the medium term. This

intervention is effective only if its volume is sizable relative to the outstanding stock of

domestic money holding. However, most studies conclude that the direct effect of

intervention on exchange rates is either statistically insignificant or quantitatively

unimportant [Rosenberg (1996)].6

The objectives of intervention differ by country and from one period to the other. The

BoJ has consistently pursued a policy of leaning against the wind. Whenever yen raised

against the dollar, the BoJ bought dollars and sold yen to moderate the yens rise; and

vice versa. While BoJ intervenes in order to moderate the trends in yen over time, the


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Bundesbank does intervene primarily for domestic monetary control. However, at times,

Bundesbank has compromised this objective in order to get the exchange rate in

alignment with its long-run rate.7 In the case of dollar however Federal Reserve has

never maintained a uniform policy for exchange rate management. While during 1978-

80 it carried out major intervention to arrest dollars decline, the period between 1981

and 1984 witnessed benign neglect toward dollars rise. In line with the Plaza Accord

dollar was encouraged to decline during 1985-86 while during 1987-92 Federal Reserve

promoted greater stability of dollar in line with Louvre Accord. From 1993 onward,

Federal Reserve has encouraged the dollar to decline.

IV. THE SIGNALING HYPOTHESIS

Mussa (1981) has proposed that interventions are the indications to future course of

monetary policy. Such signals could be particularly credible, since intervention would

give the monetary authorities an open position in a foreign currency that would result in a

loss if they failed to validate their signals. According to this signaling hypothesis, central

bank may signal contractionary (expansionary) future monetary policy by selling

(buying) the intervention currency in the foreign exchange market today. Therefore, the

current sterilized intervention alters market perception about the future course of

monetary policy according to which exchange rate will move even though sterilized

intervention currently offsets the monetary effects. This signaling channel signifies that

there is asymmetry of information between the central bank and the market participants

on future fundamentals of the exchange rate.

The signaling hypothesis may be illustrated by a standard asset-pricing-model approach

to exchange rates.

In the above process for nominal exchange rate, st is the log exchange rate at time t, ft

represents the current period fundamentals, Et is the expectations operator, and is a

( ) ( )101

jtf

tE

j

jt

s+

==


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discount factor. Following the monetary models of exchange rate, the current exchange

rate is the expected present discounted value of differences in the relative monetary

conditions which are the fundamental determinants of exchange rates.8 Given the

hypothesis that intervention at time t-k, nt-k help predict the future value of the

fundamental determinant which follows a simple autoregressive process with the

intervention signal entering exogenously together with a random disturbance term (t),

the process of fundamental is given by

where fis the autoregressive coefficient of fon its own lag and is the coefficient of kperiod lagged intervention. The variable n being the central banks net purchase of

foreign currency (US$) its coefficient would assume a positive value for the signaling

story is to be right. It signifies that the purchase of foreign currency (which is equivalent

to sales of domestic currency) at t-ksignals an expansionary monetary policy in the future

at time t. Similarly, the sale of foreign currency will be correlated with a tight monetary

policy in the future. Some of the studies as explained earlier however have utilized the

direct approach of estimating the following equation.

whereEt+1ft+j Etft+jrepresents changes in expected fundamentals.

The present study has mainly estimated the fundamental process (2) using broad money

as the proxy for fundamental and measured the ability of intervention in terms of the

estimate to forecast movements in the fundamental (expected monetary policy is being

considered as the fundamental). The hypothesis is that the purchase (sales) of US$

against rupee invokes the expectation of monetary expansion (tightening).

)2(1 tkt

nt

fft

f +

+

=

( )3101 ttn

jtf

tE

jtf

tE ++=

+

++


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V. EMPIRICAL TEST AND DISCUSSION OF RESULTS

The table-1 and 2 contain the results of various tests. The frequency table and the 2test

indicate that intervention and exchange rates are interdependent. But the movement of

exchange rate has not largely been in the direction that intervention ideally leads to. It is

observed that in 48 cases out of 70 data points rupee appreciated (depreciated) when RBI

was the net buyer (seller) of US$ while it moved in the expected direction in only 22

cases. Moreover, it would be interesting to note from the figure-1 that the exchange rate

remained more or less stable during 1996:4 1997:10 and 1998:8 2000:4 when RBI

continued to be the net buyer of US$ from the market during the former period while it

was not a consistent buyer during the later period. As the figure shows, RBI has turned

out to be a net buyer of US$ when rupee was sliding. For instance, between October

1998 and March 1999 rupee depreciated from 42.25/US$ to 42.43/US$ while RBI has

undertaken a net purchase of dollar to the tune of Rs. 10,879 during this period. Thus the

visual examination of the exchange rate and intervention data essentially indicates the

fact that intervention has not been aiming at maintaining exchange rate or alternatively it

has not been sufficient enough to pull the exchange rate in desired direction.

The test of central banks policy of leaning against the wind has been carried out byestimating an intervention equation. A positive coefficient for exchange rate in the

intervention equation is an indication of the practice of leaning against the wind which

means that central bank prevents further appreciation (depreciation) of rupee by purchase

(sale) of US$. The statistically significant and negative coefficient of exchange rate

(Rs./US$) in the intervention equation signifies that the central bank purchases US$ when

its price in terms of Indian rupee is low and vice versa. However, the variation in

monetary base found to have insignificant influence on the intervention decisions.

The figure-2 further confirms the fact that exchange rate (and intervention) does not

reflect the monetary conditions. Ideally, if the transmission mechanism works, the

monetary growth and currency value should move in opposite directions i.e., positive

growth in money supply should be offset by depreciation of exchange rates. The period


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of stable exchange rate between March 1993 and August 1995 has been the period of

wild fluctuations in money supply growth ranging between 14 per cent to as high as 22

per cent. In spite of this, rupee remained relatively stable at around 31.50/US$ until

August 1995. In September 1995, rupee closed at 34.00/US$ and subsequently remained

stable at around 35.00/US$ until July 1997. A tighter monetary policy during 1995-97

has brought down the growth of money supply to around 16 per cent on an average.

Further, rupee depreciated subsequently to move from 36.50/US$ to 42.50/US$ between

August 1997 and June 1998, and thereafter it was stabilized. Though money supply has

not grown beyond 16 per cent during this period, the fall in rupee value was on account

of declining capital inflow and weak export growth.9

Following Genberg (1976), a standard sterilization equation has been estimated to see

what extent the central bank sterilizes reserve flows. The estimated coefficient values of

foreign currency reserves (sterilization coefficient) and central banks net credit to

government in the sterilization equation capture the thrust of monetary policy to sterilize

the impact of reserve flows on monetary base. Under complete sterilization, the

coefficient of reserves would be 1 and in the absence of sterilization its value would be

zero. However, the estimated sterilization coefficient is 0.23, which signifies that RBI

sterilizes a major portion of reserve flow. There is some supporting evidence to the

signaling hypothesis as well. The test of signaling hypothesis is based on the estimates of

the equation (2) in which money supply is being used as a proxy for the fundamental

factorft. The positive coefficient of lagged intervention signifies that purchases of US$

are correlated with expansionary monetary policy. A very low coefficient value of

lagged intervention in the estimated equation indicates that it has only a marginal impact

on money supply. The direct approach of testing signaling hypothesis using equation (3)

has also not provided substantive evidence to confirm that intervention signals future

monetary conditions.

The results from test of causality indicate that intervention does not have any significant

causal relationship with monetary variable and exchange rate. However, the result shows

that, as expected, intervention causes changes in the level of foreign currency reserves.


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This gives an indication to the fact that RBI has not been buying (selling) dollars when

rupee becomes stronger (weaker) and reserve level rises (falls).

VI. Conclusion

The present study has attempted to empirically examine the impact of central banks

intervention on exchange rate and future monetary policy in the Indian context. It is

emerged from the analysis that the intervention did not have stabilizing effect on

exchange rate. On the contrary, the result showed that the central bank accumulates

foreign currency when it is cheaper and offloads when it is dearer in terms of domestic

currency. The central bank however has used intervention, though not very significantly,

for signaling future course of monetary policy. To conclude, any study in the above

directions would ideally use the daily exchange rate and intervention data. The monthly

data as has been utilized by the present study owing to the non-availability of daily

intervention data limited the results of the study to certain extent.


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Table-1: 2Test and Estimated Regression Equations

2Test

Number of months that Rs./US$ rateAppreciated when RBI is net buyer of US$ 23Depreciated when RBI is net buyer of US$ 22Appreciated when RBI is net seller of US$ 0Depreciated when RBI is net seller of US$ 25

Total 70

Chi-square 19.1*

Estimated Regression Equations

Intervention equation

nt = + 1st+ 2 bt + t0.14 -4.42 1.76

(0.44) (-2.01)** (1.23)

R2= 0.21 SEE = 0.29 D-W = 2.01 = -0.36(-3.04)

Sterilization equation

bt = + 1rt + 2gt + t0.003 0.24 0.27(0.96) (3.51)* (4.79)*

R2= 0.31 SEE = 0.02 D-W = 2.20

Test of Signaling Hypothesis

1. mt = + 1mt-1 + 2nt-1+ t0.02 -0.043 0.01

(7.41)* (-0.36) (1.90)***

R2= 0.05 SEE = 0.008 D-W = 2.01

2.

mt+1 mt = + 1nt+ t0.01 0.01(13.5)* (1.88)***

R2= 0.05 SEE = 0.008 D-W = 2.09Refer appendix for definition of variables and their notations.D-W is the Durbin-Watson statistic and values in parentheses indicate t-statistic.One, two and three asterisks indicate significance at 1%, 5% and 10% levels respectively.

is the first order autoregressive parameter.


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Table-2: Results of Granger Causality Test

mt-1 mt-2 nt-1 nt-2

mt -0.05 (-0.38) -0.029 (-0.23) 0.01 (1.67) -0.0004 (-0.106)nt 2.33 (0.49) -1.74 (-0.37) -0.41 (-3.11) -0.12 (-0.90)

P-value for ntcauses mt: 0.18, F-statistic F(2, 64)= 1.77

P-value for mtcauses nt: 0.82, F-statistic F(2, 64)= 0.196

rt-1 rt-2 nt-1 nt-2

rt -0.56 (-3.60) 0.20 (1.17) 0.067 (3.54) 0.029 (1.74)nt -3.63 (-2.74) -0.58 (-0.40) -0.14 (-0.85) 0.07 (0.47)

P-value for ntcauses rt: 0.003, F-statistic F(2, 64)= 6.53P-value for rtcauses nt: 0.024, F-statistic F(2, 64)= 3.94

st-1 st-2 nt-1 nt-2

st 0.19 (1.44) -0.20 (-1.58) -0.006 (-0.96) 0.002 (0.31)

nt 0.013 (0.005) 1.19 (0.454) -0.389 (-2.95) -0.098 (-0.741)

P-value for ntcausesst: 0.49, F-statistic F(2, 64)= 0.732P-value forstcauses nt: 0.899, F-statistic F(2, 64)= 0.106

The values in parentheses indicate t-statistic.


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Figure 1: RBI's Intervention and Exchange Rate Movements

-7500

-2500

2500

7500

12500

17500

199

5

6

199

5

8

1995

10

1995

12

199

6

2

199

6

4

199

6

6

199

6

8

1996

10

1996

12

199

7

2

199

7

4

199

7

6

199

7

8

1997

10

1997

12

199

8

2

199

8

4

199

8

6

199

8

8

1998

10

1998

12

199

9

2

199

9

4

199

9

6

199

9

8

1999

10

1999

12

200

0

2

200

0

4

200

0

6

200

0

8

2000

10

2000

12

200

1

2

200

1

4

Year and Month

US$PurchasebyRBI

(inRs.

Crore)

0

5

10

15

20

25

30

35

40

45

50

Rs/US$exchangerates

Rs/US$ rates

US$ Purchase


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Figure 2: Monetary Growth and Exchange Rates

10

15

20

25

30

35

40

45

50

1995

6

1995

9

1995

12

1996

3

1996

6

1996

9

1996

12

1997

3

1997

6

1997

9

1997

12

1998

3

1998

6

1998

9

1998

12

1999

3

1999

6

1999

9

1999

12

2000

3

2000

6

2000

9

2000

12

2001

3

Year and Month

Rs/US$Rates

10.00

12.00

14.00

16.00

18.00

20.00

22.00

24.00

M3 growth

Rs/US$ rates

M3growthrates


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ENDNOTES

1. In the Indian context, Reserve Bank of India uses US$ as the intervention currencywhich is being bought and sold against Indian rupee in the market.

2. There are also studies, e.g., Neely (2000) which deal with mechanics, timing,instruments and purpose of secrecy of intervention which are not being reviewed

here.

3. This study is the most recent one to offer a fairly comprehensive survey of research inthe area of central bank intervention.

4. Friedman in his seminal work on flexible exchange rate system has argued that acentral bank which was stabilizing the exchange rate would tend to buy foreign

exchange when its price was low, and sell when its price was high, and hence itsoperations would be profitable. Taking the cue from this intervention rule it is argued

that the existence of profits over long periods provides a strong case for the view that

central bank intervention has been effective in stabilizing the exchange rate.

5. The test proposed by Wonnacott (1982) indicates that intervention is stabilizing if itreduces the variance of exchange rate around its trend. It involves measuring whether

the direction of intervention is consistent with pushing the exchange rate back

towards its long-run moving average.

6. Against the consensus view in the early 1980s that central bank intervention isineffective, Dominguez and Frankel (1993) in their seminal study argue that when the

authorities are prepared to intervene at a particular upper or lower limit they will

achieve a higher degree of success in stabilizing the currency with a smaller amount

of intervention if they publicly announce these limits ahead of time. In the light of

these findings, the Committee on Capital Account Convertibility in India headed by

Shri. S.S. Tarapore recommended that a REER-monitoring band be declared to enable

the participants to anchor expectations on when RBI would intervene and when it

would not for making its intervention more effective [Tarapore (1997)].

7. After the formal unification of Europe, Bundesbank implements exchange rate policyand conducts foreign exchange operations consistent with the provisions of Article

109 of the Treaty of European Union.


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8. In the formulation of ft, it is assumed that the growth of money supply in rest of theworld was constant. Therefore,ft represented the change in money supply conditions

in the domestic economy alone.

9. The impact of monetary policy on the behavior of rupee exchange rate andinternational reserves in the Indian context has been empirically examined in

Sahadevan (1999) using Girton-Roper model of exchange market pressure.

APPENDIX

Definition of Variables and Methodology of the Study

The present study has been carried out on monthly data for a period starting from June

1995 through May 2001. The choice of starting period of the sample coincides with the

availability of data on RBIs intervention. The variables used in the study are defined as

follows: reserve money (b), broad money (m) i.e. M1 plus time deposit liabilities of

banks, foreign exchange reserves (r) is the rupee value of foreign currency assets with

RBI, exchange rate (s) is the monthly average rate of the rupee vis--vis US$ which is

measured in rupees per unit of US$, and central banks net credit to government (g) is the

central governments net borrowings from RBI. The intervention variable (n) is the rupee

equivalent of monthly net purchase (positive values)/net sales (negative values) of US$

by the Reserve Bank of India in the spot and forward segments. The sources of data are

RBI BulletinandRBI Handbook of Statistics on Indian Economy.

The ordinary least square (OLS) method is used for estimating the equations specified in

section IV. The possibility of serial correlation problem has been verified by using

Durbin-Watson test statistics the values of which are reported against all estimated

equations. In those cases where serial correlation is detected, the coefficient estimatesare adjusted by using Cochrane-Orcutt method and the first order autoregressive

parameter () is reported along with its t-statistics. The causality between intervention,

monetary variable and foreign exchange reserves has been tested using Granger test

which is based on a simple logic that a variable Yis caused by X if Y can be predicted

better from past values of YandXthan from past values of Yalone.


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Baillie, Richard T and William P. Osterberg; Central bank intervention and risk in theforward market,Journal of International Economics, Vol.43, 1997, pp.483-497.

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