Exchange rate volatility and the effectiveness of FX interventions: The case of Chile

Abstract

In this paper, we study the effectiveness of FX interventions in Chile since adopting a fully flexible exchange rate regime in the late 1990s. In particular, we ask whether these interventions have dumped excess exchange rate volatility and reduced its probability of being in a high volatility state. To do so, we rely on a high-frequency GARCH(1,1) volatility model with Markov-Switching regimes and evaluate the effectiveness of FX interventions within a local projection setting. We show that FX interventions in Chile tend to occur during high exchange rate volatility periods, which correlate with domestic and foreign financial factors. Moreover, we show that the FX intervention that started by the end of 2019–the latest intervention included in our study–effectively reduced the exchange rate volatility and the probability of being at a high volatility state.