One Role of FX reserves and Exchange Rate Volatility

Abstract

The financial crisis in the United States (2007-2009) affected most countries through certain factors such as the exchange rate. Before the crisis, it was generally believed that if a country falls in a recession, then its currency would depreciate. During the financial crisis, however, the US dollar appreciated substantially vis-à-vis all other currencies except for few. The previous papers explained unexpected movement of the exchange rate by investigating transmission channels of the crisis and its main resources. But none of the papers explained the exchange rate volatility between US dollar and other currencies. Therefore, this paper focuses on the volatility and shows that only FX reserves can account for the magnitude of exchange rate volatility in emerging market economy irrespective of economic situations.