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Bulls, Bears and Excess Volatility: can currency intervention help?

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  • Corrado, L.
  • Miller, M.
  • Zhang, L.

Abstract

Asset mis-pricing may reflect investor psychology, with excess volatility arising from switches of sentiment. For a floating exchange rate where fundamentals follow a random walk, we show that excess volatility can be generated by the repeated entry and exit of currency `bulls' and `bears' with switches driven by `draw-down' trading rules. We argue that non-sterilised intervention - in support of `monitoring band' - can reduce excess volatility by coordinating beliefs in line with policy. Strategic complementarity in the foreign exchange market suggests that sterilised intervention may also play a coordinating role.

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File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe0708.pdf
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Bibliographic Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0708.

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Length: 29
Date of creation: Jan 2007
Date of revision:
Handle: RePEc:cam:camdae:0708

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Related research

Keywords: Monitoring Rules; Monitoring Band; Bear and Bull Traders; Excess Volatility; Central Bank Intervention.;

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References

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  1. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
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  9. Luisa Corrado & Marcus Miller & Lei Zhang, 2007. "Exchange Rate Monitoring Bands: Theory and Policy," Money Macro and Finance (MMF) Research Group Conference 2006 146, Money Macro and Finance Research Group.
  10. Frankel, David M. & Morris, Stephen & Pauzner, Ady, 2003. "Equilibrium Selection in Global Games with Strategic Complementarities," Staff General Research Papers 11920, Iowa State University, Department of Economics.
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Citations

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Cited by:
  1. Yi-Fang Liu & Chao Xu & Wei Zhang & J{\o}rgen Vitting Andersen, 2013. "Impact of information cost and switching of trading strategies in an artificial stock market," Papers 1311.4274, arXiv.org.
  2. Michael Melvin & Lukas Menkhoff & Maik Schmeling, 2008. "Automating Exchange Rate Target Zones: Intervention via an Electronic Limit Order Book," CESifo Working Paper Series 2221, CESifo Group Munich.
  3. Paul De Grauwe & Pablo Rovira Kaltwasser, 2007. "Modeling Optimism and Pessimism in the Foreign Exchange Market," CESifo Working Paper Series 1962, CESifo Group Munich.

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