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Option prices, exchange market intervention, and the higher moment expectations channel: a user's guide

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Author Info
Gabriele Galati (Monetary and Economic Department, Bank for International Settlements, Switzerland)
Patrick Higgins (Research Department, Federal Reserve Bank of Cleveland, USA)
Owen Humpage (Research Department, Federal Reserve Bank of Cleveland, USA)
William Melick (Department of Economics, Kenyon College, USA)

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Abstract

A vast literature on the effects of sterilized intervention by the monetary authorities in the foreign exchange markets concludes that intervention systematically moves the spot exchange rate only if it is publicly announced, coordinated across countries, and consistent with the underlying stance of fiscal and monetary policy. Over the past 15 years, researchers have also attempted to determine if intervention has any effects on the dispersion and directionality of market views concerning the future exchange rate. These studies usually focus on the variance around the expected future exchange rate-the second moment. In this paper we demonstrate how to use over-the-counter option prices to recover the risk-neutral probability density function (PDF) for the future exchange rate. Using the yen|dollar exchange rate as an example, we calculate measures of dispersion and directionality, such as variance and skewness, from estimated PDFs to test whether intervention by the Japanese Ministry of Finance during the period 1996-2004 had any impact on the higher moments of the exchange rate. We find little or no systematic effect, consistent with the findings of the literature on the spot rate as: Japanese intervention was not publicly announced prior to August 2000, and since that time only publicly announced after the fact, over the past 10 years rarely coordinated across countries and, in hindsight, probably inconsistent with the underlying stance of monetary policy. Copyright © 2007 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.325
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Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 12 (2007)
Issue (Month): 2 ()
Pages: 225-247
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Handle: RePEc:ijf:ijfiec:v:12:y:2007:i:2:p:225-247

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
  3. Kathryn M. E. Dominguez, 2003. "When Do Central Bank Interventions Influence Intra-Daily and Longer-Term Exchange Rate Movements?," Working Papers 506, Research Seminar in International Economics, University of Michigan. [Downloadable!]
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    Other versions:
  6. Malz, Allan M., 1996. "Using option prices to estimate realignment probabilities in the European Monetary System: the case of sterling-mark," Journal of International Money and Finance, Elsevier, vol. 15(5), pages 717-748, October. [Downloadable!] (restricted)
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    Other versions:
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  23. Merton, Robert C, 1981. "On Market Timing and Investment Performance. I. An Equilibrium Theory of Value for Market Forecasts," Journal of Business, University of Chicago Press, vol. 54(3), pages 363-406, July. [Downloadable!] (restricted)
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  30. Kearns, Jonathan & Rigobon, Roberto, 2005. "Identifying the efficacy of central bank interventions: evidence from Australia and Japan," Journal of International Economics, Elsevier, vol. 66(1), pages 31-48, May. [Downloadable!] (restricted)
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  32. Kathryn M. Dominguez, 1993. "Does Central Bank Intervention Increase the Volatility of Foreign Exchange Rates?," NBER Working Papers 4532, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  33. Almekinders, Geert J. & Eijffinger, Sylvester C. W., 1996. "A friction model of daily Bundesbank and Federal Reserve intervention," Journal of Banking & Finance, Elsevier, vol. 20(8), pages 1365-1380, September. [Downloadable!] (restricted)
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    Other versions:
  37. Galati, Gabriele & Melick, William & Micu, Marian, 2005. "Foreign exchange market intervention and expectations: The yen/dollar exchange rate," Journal of International Money and Finance, Elsevier, vol. 24(6), pages 982-1011, October. [Downloadable!] (restricted)
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  40. repec:rus:hseeco:21608 is not listed on IDEAS
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    Other versions:
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    Other versions:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Michel Beine & Oscar Bernal & Jean-Yves Gnabo & Christelle Lecourt, 2007. "Intervention Policy of the BoJ: a Unified Approach," Working Papers of CREFI-LSF (Centre of Research in Finance - Luxembourg School of Finance) 07-19, CREFI-LSF, University of Luxembourg. [Downloadable!]
    Other versions:
  2. Rasmus Fatum, 2009. "Official Japanese Intervention in the JPY/USD Exchange Rate Market: Is It Effective and Through Which Channel Does It Work?," IMES Discussion Paper Series 09-E-12, Institute for Monetary and Economic Studies, Bank of Japan. [Downloadable!]
  3. Yushi Yoshida & Jan C. Rülke, 2009. "On-Going versus Completed Interventions and Yen/Dollar Expectations - Evidence from Disaggregated Survey Data," Discussion Papers 35, Kyushu Sangyo University, Faculty of Economics. [Downloadable!]
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