BOK Cites Shallow Forex Market, High Exposure to Capital Outflows Impacting Korean Won Volatility
The Korean won experiences greater volatility compared to major global currencies, primarily due to the limited depth of its foreign exchange (forex) market. This lack of sufficient buy and sell orders across various price levels was highlighted by Bank of Korea (BOK) economists on Thursday.
According to a recent central bank analysis, the won exhibits a more pronounced reaction to significant capital outflow shocks when compared to currencies in more developed, advanced economies.
Korea’s estimated sensitivity to such capital shocks registers at 0.65. While this is slightly below the emerging market average of 0.71, it significantly surpasses Japan’s 0.38, indicating that the Korean won currency is much more susceptible to sharp movements in response to similar external economic pressures.
“This notable difference in currency sensitivity appears directly linked to the depth of the forex market,” explained Kim Ji-hyun, a BOK economist. She emphasized the relatively shallow liquidity observed within the won-dollar market.
Limited market depth translates to lower overall trading volumes. With fewer market participants and smaller individual order sizes, the market struggles to absorb large transactions without triggering significant and sudden price swings, contributing to heightened currency volatility.
“In light of this, recent strategic efforts by Korea to achieve inclusion in prominent global indices, such as the FTSE World Government Bond Index (WGBI), and secure an upgrade in its MSCI classification, could prove highly relevant and beneficial,” Kim Ji-hyun added, suggesting these moves could enhance market depth and stability.
Furthermore, the primary drivers influencing the Korean won have evolved over time. While exports were the dominant force behind currency appreciation until approximately 2014, capital flows now play a much more significant and influential role in shaping the won’s value, according to Kim Ji-hyun.
The BOK study also revealed a substantial concentration of Korea’s external securities investments in US assets, accounting for 63 percent. This figure far exceeds the average of 25 percent seen across other advanced economies. This heavy concentration amplifies Korea’s exposure to external shocks and further contributes to the won’s currency volatility.
“A growing share of US assets is a natural part of economic development for an advanced economy like Korea,” commented Kim Min, another BOK economist. However, he cautioned that no single factor fully accounts for this complex trend in asset allocation and its impact on currency stability.
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