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A market microstructure analysis of foreign exchange intervention

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Author Info
Paolo Vitale () (Department of Economics and Land History, Gabriele D‘Annunzio University, Viale Pindaro 42, 65127 Pescara (Italy).)

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Abstract

We formulate a market microstructure model of exchange determination we employ to investigate the impact of foreign exchange intervention on exchange rates and on foreign exchange (FX) market conditions. With our formulation we show i) how foreign exchange intervention influences exchange rates via both a portfolio-balance and a signalling channel and ii) derive a series of testable implications which are coherent with a large body of empirical research. Our investigation also proposes some normative recommendations, as we show i) that in extreme circumstances large scale foreign exchange intervention can have destabilizing effects for the functioning of FX markets and ii) that the route chosen for the implementation of official intervention has important implications for its impact on exchange rates and on market conditions. JEL Classification: D82; G14; G15.

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Paper provided by European Central Bank in its series Working Paper Series with number 629.

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Length: 57 pages
Date of creation: May 2006
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Handle: RePEc:ecb:ecbwps:20060629

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Keywords: Official intervention; order flow; foreign exchange micro structure; exchange rate dynamics.;

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  1. Payne, Richard, 2003. "Informed trade in spot foreign exchange markets: an empirical investigation," Journal of International Economics, Elsevier, vol. 61(2), pages 307-329, December. [Downloadable!] (restricted)
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  3. Li, Hongzhe, 2006. "Comment," Journal of the American Statistical Association, American Statistical Association, vol. 101, pages 114-115, March. [Downloadable!] (restricted)
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  6. Charles Engel & Kenneth D. West, 2005. "Exchange Rates and Fundamentals," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 485-517, June.
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  7. Peter Welz, 2006. "Assessing predetermined expectations in the standard sticky-price model - a Bayesian approach," Working Paper Series 621, European Central Bank. [Downloadable!]
  8. Ana Lamo & Julián Messina & Etienne Wasmer, 2006. "Are specific skills an obstacle to labor market adjustment? Theory and an application to the EU enlargement," Working Paper Series 585, European Central Bank. [Downloadable!]
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  9. Martin D. D. Evans & Richard K. Lyons, 2002. "Order Flow and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 110(1), pages 170-180, February. [Downloadable!] (restricted)
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  10. Philippe Bacchetta & Eric Van Wincoop, 2006. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," American Economic Review, American Economic Association, vol. 96(3), pages 552-576, June. [Downloadable!]
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  11. Lyons, Richard K., 1995. "Tests of microstructural hypotheses in the foreign exchange market," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 321-351. [Downloadable!] (restricted)
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  12. Michael Ehrmann & Marcel Fratzscher, 2006. "Global financial transmission of monetary policy shocks," Working Paper Series 616, European Central Bank. [Downloadable!]
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  13. Daniel A. Dias & Carlos Robalo Marques & João M. C. Santos Silva, 2006. "Measuring the importance of the uniform nonsynchronization hypothesis," Working Paper Series 606, European Central Bank. [Downloadable!]
  14. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Vega, Clara, 2002. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," Working Papers 02-16, Duke University, Department of Economics. [Downloadable!]
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  15. Kenneth A. Froot & Tarun Ramadorai, 2005. "Currency Returns, Intrinsic Value, and Institutional-Investor Flows," Journal of Finance, American Finance Association, vol. 60(3), pages 1535-1566, 06. [Downloadable!] (restricted)
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  18. Breedon, Francis & Vitale, Paolo, 2004. "An Empirical Study of Liquidity and Information Effects of Order Flow on Exchange Rates," CEPR Discussion Papers 4586, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  19. Robert J. Tetlow & Peter von zur Muehlen, 2005. "Robustifying learnability," Finance and Economics Discussion Series 2005-58, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  20. Bhattacharya, Utpal & Weller, Paul, 1997. "The advantage to hiding one's hand: Speculation and central bank intervention in the foreign exchange market," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 251-277, July. [Downloadable!] (restricted)
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  23. Michel Juillard & Philippe Karam & Douglas Laxton & Paolo Pesenti, 2006. "Welfare-based monetary policy rules in an estimated DSGE model of the US economy," Working Paper Series 613, European Central Bank. [Downloadable!]
  24. Ignazio Angeloni & Luc Aucremanne & Matteo Ciccarelli, 2006. "Price setting and inflation persistence: did EMU matter?," Working Paper Series 597, European Central Bank. [Downloadable!]
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  25. Michael Ehrmann, 2006. "Rational inattention, inflation developments and perceptions after the euro cash changeover," Working Paper Series 588, European Central Bank. [Downloadable!]
  26. Marco Hoeberichts & Ad Stokman, 2006. "Price setting behaviour in the Netherlands - results of a survey," Working Paper Series 607, European Central Bank. [Downloadable!]
  27. Antonio Fatás & Ilian Mihov & Andrew K. Rose, 2006. "Quantitative goals for monetary policy," Working Paper Series 615, European Central Bank. [Downloadable!]
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  28. Christopher J. Neely, 2000. "The practice of central bank intervention: looking under the hood," Working Papers 2000-028, Federal Reserve Bank of St. Louis. [Downloadable!]
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  29. Vitale, Paolo, 1999. "Sterilised central bank intervention in the foreign exchange market," Journal of International Economics, Elsevier, vol. 49(2), pages 245-267, December. [Downloadable!] (restricted)
  30. Payne, Richard & Vitale, Paolo, 2003. "A transaction level study of the effects of central bank intervention on exchange rates," Journal of International Economics, Elsevier, vol. 61(2), pages 331-352, December. [Downloadable!] (restricted)
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  31. Bjonnes, Geir Hoidal & Rime, Dagfinn, 2005. "Dealer behavior and trading systems in foreign exchange markets," Journal of Financial Economics, Elsevier, vol. 75(3), pages 571-605, March. [Downloadable!] (restricted)
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  32. Vitale, Paolo, 2004. "A Guided Tour of the Market Microstructure Approach to Exchange Rate Determination," CEPR Discussion Papers 4530, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  33. Tsutomu Watanabe, 1992. "The signaling effect of foreign exchange intervention: the case of Japan," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  34. Popper, Helen & Montgomery, John D., 2001. "Information sharing and central bank intervention in the foreign exchange market," Journal of International Economics, Elsevier, vol. 55(2), pages 295-316, December. [Downloadable!] (restricted)
  35. Anindya Banerjee & Josep Lluís Carrion-i-Silvestre, 2006. "Cointegration in Panel Data with Breaks and Cross-Section Dependence," Economics Working Papers ECO2006/5, European University Institute. [Downloadable!]
  36. Lewis, Karen K, 1995. "Are Foreign Exchange Intervention and Monetary Policy Related, and Does It Really Matter?," Journal of Business, University of Chicago Press, vol. 68(2), pages 185-214, April. [Downloadable!] (restricted)
  37. Tsutomu Watanabe, 1992. "The signaling effect of foreign exchange intervention: the case of Japan," Proceedings, Federal Reserve Bank of San Francisco, pages 258-286.
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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. Rasmus Fatum & Jesper Pedersen, 2007. "Real-Time Effects of Central Bank Interventions in the Euro Market," EPRU Working Paper Series 07-01, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics. [Downloadable!]
  2. Lukas Menkhoff, 2008. "High-Frequency Analysis of Foreign Exchange Interventions: What do we learn?," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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