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Regime switching behavior of the nominal exchange rate in Uganda

Regime switching behavior of the nominal exchange rate in Uganda Purpose – This paper aims to examine regime switching behaviour of the nominal exchange rate in Uganda to shed light on the necessity (as well as efficacy) of the participation of the central bank market. Design/methodology/approach – The homogenous two‐state Markov chain methodology was employed to investigate the possibility of regime changes in the nominal exchange rate. The maximum likelihood parameter estimates were obtained using the Broyden‐Fletcher‐Goldfarb‐Shanno iteration algorithm. Findings – The results validate the expectation of the two distinct state spaces characterized as sharp and disruptive but short‐lived depreciations as well as small appreciations occurring through a long period. The central bank intervention actions are shown to be largely successful in mitigating the disruptive effects of the sharp depreciations. Practical implications – The paper lends empirical support to the intervention actions of the Bank of Uganda. In face of the numerous disruptions to the short‐term exchange rate process, failure to intervene may cause rational panic and given the nature of investor behavior, this may quickly spread and even cause further disruptions. It is important for the central bank to send signals that these disruptions are temporary. Originality/value – The homogenous Markov chain specification employed in this study makes it possible to avoid the pitfalls that may arise by attempting to specify a structural model for the exchange rate. In addition, inference about the different possible state spaces is made on the basis of all available information. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png African Journal of Economic and Management Studies Emerald Publishing

Regime switching behavior of the nominal exchange rate in Uganda

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Publisher
Emerald Publishing
Copyright
Copyright © 2011 Emerald Group Publishing Limited. All rights reserved.
ISSN
2040-0705
DOI
10.1108/20400701111165632
Publisher site
See Article on Publisher Site

Abstract

Purpose – This paper aims to examine regime switching behaviour of the nominal exchange rate in Uganda to shed light on the necessity (as well as efficacy) of the participation of the central bank market. Design/methodology/approach – The homogenous two‐state Markov chain methodology was employed to investigate the possibility of regime changes in the nominal exchange rate. The maximum likelihood parameter estimates were obtained using the Broyden‐Fletcher‐Goldfarb‐Shanno iteration algorithm. Findings – The results validate the expectation of the two distinct state spaces characterized as sharp and disruptive but short‐lived depreciations as well as small appreciations occurring through a long period. The central bank intervention actions are shown to be largely successful in mitigating the disruptive effects of the sharp depreciations. Practical implications – The paper lends empirical support to the intervention actions of the Bank of Uganda. In face of the numerous disruptions to the short‐term exchange rate process, failure to intervene may cause rational panic and given the nature of investor behavior, this may quickly spread and even cause further disruptions. It is important for the central bank to send signals that these disruptions are temporary. Originality/value – The homogenous Markov chain specification employed in this study makes it possible to avoid the pitfalls that may arise by attempting to specify a structural model for the exchange rate. In addition, inference about the different possible state spaces is made on the basis of all available information.

Journal

African Journal of Economic and Management StudiesEmerald Publishing

Published: Sep 20, 2011

Keywords: Nominal exchange rate; Regime switching; Central bank intervention; Exchange rates; Central banks

References