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Friction model and foreign exchange market intervention

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  • Jun, Jongbyung
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    Abstract

    The friction model is consistent with the hypothesis that a central bank intervenes in a foreign exchange market only if the necessity grows beyond certain thresholds. For this feature, the model is adopted in some recent studies as an attractive central bank reaction function. However, with official data on Federal Reserve and Bundesbank intervention, this paper shows that the friction model's advantage relative to a linear model may be negligible in terms of RMSE and MAE of in-sample fitting and out-of-sample forecasts. The implication is that intervention decisions are at the monetary authorities' discretion rather than dictated by a rule.

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    File URL: http://www.sciencedirect.com/science/article/B6W4V-4NDMNH8-1/1/3e1b4a43a66e45d87691c3f19b06edbb
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    Bibliographic Info

    Article provided by Elsevier in its journal International Review of Economics & Finance.

    Volume (Year): 17 (2008)
    Issue (Month): 3 ()
    Pages: 477-489

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    Handle: RePEc:eee:reveco:v:17:y:2008:i:3:p:477-489

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    Web page: http://www.elsevier.com/locate/inca/620165

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    References

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    1. Frenkel, Michael & Pierdzioch, Christian & Stadtmann, Georg, 2005. "Japanese and U.S. interventions in the yen/U.S. dollar market: estimating the monetary authorities' reaction functions," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(4-5), pages 680-698, September.
    2. Kim, Suk-Joong & Sheen, Jeffrey, 2002. "The determinants of foreign exchange intervention by central banks: evidence from Australia," Journal of International Money and Finance, Elsevier, vol. 21(5), pages 619-649, October.
    3. Owen F. Humpage, 1996. "U.S. intervention: assessing the probability of success," Working Paper 9608, Federal Reserve Bank of Cleveland.
    4. Christopher J. Neely, 2001. "The practice of central bank intervention: looking under the hood," Review, Federal Reserve Bank of St. Louis, issue May, pages 1-10.
    5. Christopher J. Neely, 2006. "Identifying the effects of U.S. intervention on the levels of exchange rates," Working Papers 2005-031, Federal Reserve Bank of St. Louis.
    6. Baillie, Richard T. & Osterberg, William P., 1997. "Why do central banks intervene?," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 909-919, December.
    7. Baillie, Richard T. & Osterberg, William P., 2000. "Deviations from daily uncovered interest rate parity and the role of intervention," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 10(3-4), pages 363-379, December.
    8. Almekinders, G.J. & Eijffinger, S.C.W., 1994. "The ineffectiveness of central bank intervention," Discussion Paper 1994-101, Tilburg University, Center for Economic Research.
    9. Neely, Christopher J., 2002. "The temporal pattern of trading rule returns and exchange rate intervention: intervention does not generate technical trading profits," Journal of International Economics, Elsevier, vol. 58(1), pages 211-232, October.
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    Cited by:
    1. Hsiao, Yu-Ming & Pan, Sheng-Chieh & Wu, Po-Chin, 2012. "Does the central bank's intervention benefit trade balance? Empirical evidence from China," International Review of Economics & Finance, Elsevier, vol. 21(1), pages 130-139.
    2. Chen, Ho-Chyuan & Chang, Kuang-Liang & Yu, Shih-Ti, 2012. "Application of the Tobit model with autoregressive conditional heteroscedasticity for foreign exchange market interventions," Japan and the World Economy, Elsevier, vol. 24(4), pages 274-282.

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