The Effect of Capital Controls on Exchange Rate Risk

Abstract

Many countries try to smooth their exchange rate movements by means of capital controls or otherwise. By the use of statistical extreme value analysis, we investigate if capital controls succeed in lowering foreign exchange rate (forex) volatility. We define forex volatility as the risk of extreme depreciations. For a sample of developed and emerging markets we find that capital controls are not effective in reducing this extreme depreciation risk. On the contrary, extreme depreciation risk is almost twice as high compared to an exchange rate regime without capital controls.