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A Test for the Presence of Central Bank Intervention in the Foreign Exchange Market With an Application to the Bank of Canada

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  • Douglas James Hodgson

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Abstract

We propose a general non-linear simultaneous equations framework for the econometric analysis of models of intervention in foreign exchange markets by central banks in response to deviations of exchange rates from target levels. We consider the instrumental variables estimation of possibly non-linear response functions and tests of intervention when the functional form may be non-linear, asymmetric, and may contain unknown shape parameters. The methodology applies techniques developed for testing in the presence of nuisance parameters unidentified under a null hypothesis to a nonlinear simultaneous equations model. We report the results of an empirical analysis of activity of the Bank of Canada, for the period from 1953-2006, with regard to the Canada-U.S. exchange rate, with changes in foreign reserves proxying for intervention activity. Nous proposons un cadre de référence général pour les équations non-linéaires simultanées s’appliquant à l’analyse économétrique de modèles d’intervention des banques centrales dans les marchés des devises étrangères, en réponse aux écarts des taux de change par rapport aux niveaux cibles. Nous prenons en considération l’estimation des variables instrumentales liées aux fonctions de réponses possiblement non-linéaires et aux tests en matière d’interventions lorsque la forme fonctionnelle peut être non linéaire, asymétrique et lorsqu’elle peut contenir des paramètres de forme inconnue. La méthodologie applique, à un modèle à équations simultanées non linéaires, des techniques élaborées pour effectuer des tests en présence de paramètres de nuisance non identifiés sous une hypothèse nulle. Nous présentons les résultats d’une analyse empirique des activités de la Banque du Canada, durant la période de 1953-2006, relativement au taux de change Canada-É.-U., les variations des réserves étrangères permettant les activités d’intervention.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2009s-14.

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Date of creation: 01 Apr 2009
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Handle: RePEc:cir:cirwor:2009s-14

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Keywords: unidentified nuisance parameter; nonlinear simultaneous equations; foreign exchange reserves; policy reaction functions; paramètre de nuisance non identifié; équations simultanées non linéaires; réserves de change; fonctions de réaction de la politique;

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  1. Hamilton, James D., 1999. "A Parametric Approach to Flexible Nonlinear Inference," University of California at San Diego, Economics Working Paper Series qt68s8157x, Department of Economics, UC San Diego.
  2. Donald W.K. Andrews & Werner Ploberger, 1992. "Optimal Tests When a Nuisance Parameter Is Present Only Under the Alternative," Cowles Foundation Discussion Papers 1015, Cowles Foundation for Research in Economics, Yale University.
  3. Hausman, Jerry A, 1978. "Specification Tests in Econometrics," Econometrica, Econometric Society, vol. 46(6), pages 1251-71, November.
  4. Gartner, Manfred, 1987. "Intervention Policy under Floating Exchange Rates: An Analysis of the Swiss Case," Economica, London School of Economics and Political Science, vol. 54(216), pages 439-53, November.
  5. Rudiger Dornbusch, 1980. "Exchange Rate Economics: Where Do We Stand?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 143-206.
  6. 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.
  7. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, vol. 64(2), pages 413-30, March.
  8. Eijffinger, S.C.W., 1991. "Empirical evidence on foreign exchange market intervention: Where do we stand?," Open Access publications from Tilburg University urn:nbn:nl:ui:12-152907, Tilburg University.
  9. Newey, Whitney K, 1990. "Semiparametric Efficiency Bounds," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 5(2), pages 99-135, April-Jun.
  10. Rogers, J. M. & Siklos, P. L., 2003. "Foreign exchange market intervention in two small open economies: the Canadian and Australian experience," Journal of International Money and Finance, Elsevier, vol. 22(3), pages 393-416, June.
  11. Longworth, David, 1980. "Canadian Intervention in the Foreign Exchange Market: A Note," The Review of Economics and Statistics, MIT Press, vol. 62(2), pages 284-87, May.
  12. Bryan W. Brown & Douglas J. Hodgson, 2007. "Semiparametric efficiency bounds in dynamic non-linear systems under elliptical symmetry," Econometrics Journal, Royal Economic Society, vol. 10(1), pages 35-48, 03.
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