Exchange Rate Volatility and Comparative Interest Rates: The Determinants of Capital Flows and Resident Dollarization in Turkey

In this study, the effects of the volatility shocks in the exchange rate on the resident dollarization and the net capital flows are discussed. The volatility of the exchange rate is derived using EGARCH model. ARDL method is used to model the effects of foreign exchange rate volatility on capital flows and dollarization in the long and short term. Additionally, the interest rate series of the relevant foreign currencies have been added to the model to represent the influence of the changes in the interest rate policies in this context. Findings indicate that, in terms of influencing capital flows and resident dollarization, interest rate policies have a significant effect in the short-run while having an even stronger effect in the long run. Additionally, exchange rate shocks have been found to have a limited effect on capital outflows and resident dollarization. Results suggest that the decision making process of investors and residents is not impulsive and even during the periods of excessive exchange rate volatility, the capital outflows and the resident dollarization are significantly more affected by interest rate changes than exchange rate shocks.