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Intervention and the foreign exchange risk premium: an empirical investigation of daily effects

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  • Owen F. Humpage
  • William P. Osterberg

Abstract

Currency markets have witnessed a sharp increase in government intervention since 1985. Many observers believe that this intervention promoted the dollar's depreciation between 1985 and early 1987, and that intervention has since helped to stabilize dollar exchange rates. This paper tests for a systematic effect of daily dollar intervention on exchange rate risk premia. We test for both portfolio balance effects and signaling influences by using daily data on central bank intervention (in dollars) against both the yen and the West German mark. Following work by Dominguez (1989) and Loopesko (1984), we measure the daily risk premium in terms of the deviation from uncovered interest parity. However, we follow other empirical analyses of exchange rates and allow for generalized conditional autoregressive heteroscedasticity (GARCH). Some evidence is found for both the portfolio balance and signaling channels.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 9009.

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Date of creation: 1990
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Handle: RePEc:fip:fedcwp:9009

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Keywords: Foreign exchange - Law and legislation;

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References

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  1. Warren E. Weber, 1986. "Do sterilized interventions affect exchange rates?," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Sum, pages 14-23.
  2. Branson, William H. & Henderson, Dale W., 1985. "The specification and influence of asset markets," Handbook of International Economics, Elsevier, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 15, pages 749-805 Elsevier.
  3. McCurdy, Thomas H & Morgan, Ieuan G, 1988. "Testing the Martingale Hypothesis in Deutsche Mark Futures with Models Specifying the Form of Heteroscedasticity," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 3(3), pages 187-202, July-Sept.
  4. Engel, Charles & Rodrigues, Anthony P, 1989. "Tests of International CAPM with Time-Varying Covariances," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 4(2), pages 119-38, April-Jun.
  5. Robert E. Cumby, 1987. "Is it Risk? Explaining Deviations from Uncovered Interest Parity," NBER Working Papers 2380, National Bureau of Economic Research, Inc.
  6. Alberto Giovannini & Philippe Jorion, 1988. "The Time-Variation of Risk and Return in the Foreign Exchange and Stock Markets," NBER Working Papers 2573, National Bureau of Economic Research, Inc.
  7. Loopesko, Bonnie E., 1984. "Relationships among exchange rates, intervention, and interest rates: An empirical investigation," Journal of International Money and Finance, Elsevier, Elsevier, vol. 3(3), pages 257-277, December.
  8. Lyons, Richard K., 1988. "Tests of the foreign exchange risk premium using the expected second moments implied by option pricing," Journal of International Money and Finance, Elsevier, Elsevier, vol. 7(1), pages 91-108, March.
  9. Johnson, David, 1988. "The currency denomination of long-term debt in the Canadian corporate sector: An empirical analysis," Journal of International Money and Finance, Elsevier, Elsevier, vol. 7(1), pages 77-90, March.
  10. Backus, David K. & Kehoe, Patrick J., 1989. "On the denomination of government debt : A critique of the portfolio balance approach," Journal of Monetary Economics, Elsevier, Elsevier, vol. 23(3), pages 359-376, May.
  11. Mark, Nelson C., 1988. "Time-varying betas and risk premia in the pricing of forward foreign exchange contracts," Journal of Financial Economics, Elsevier, Elsevier, vol. 22(2), pages 335-354, December.
  12. Lastrapes, William D, 1989. "Exchange Rate Volatility and U.S. Monetary Policy: An ARCH Application," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 21(1), pages 66-77, February.
  13. Baillie, Richard T & Bollerslev, Tim, 2002. "The Message in Daily Exchange Rates: A Conditional-Variance Tale," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 20(1), pages 60-68, January.
  14. Owen F. Humpage, 1984. "Dollar intervention and the deutschemark-dollar exchange rate: a daily time-series model," Working Paper 8404, Federal Reserve Bank of Cleveland.
  15. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, Elsevier, vol. 10(3), pages 335-359.
  16. Hali J. Edison, 1990. "Foreign currency operations: an annotated bibliography," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 380, Board of Governors of the Federal Reserve System (U.S.).
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Citations

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Cited by:
  1. Kaminsky, Graciela L. & Lewis, Karen K., 1996. "Does foreign exchange intervention signal future monetary policy?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 37(2-3), pages 285-312, April.
  2. Sarno, Lucio & Taylor, Mark P, 2001. "Official Intervention in the Foreign Exchange Market: Is It Effective, and, If So, How Does It Work?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2690, C.E.P.R. Discussion Papers.
  3. Leachman, Lori L. & Francis, Bill, 1995. "Long-run relations among the G-5 and G-7 equity markets: Evidence on the Plaza and Louvre Accords," Journal of Macroeconomics, Elsevier, Elsevier, vol. 17(4), pages 551-577.
  4. Frenkel, Michael & Pierdzioch, Christian & Stadtmann, Georg, 2004. "On the determinants of "small" and "large" foreign exchange market interventions: The case of the Japanese interventions in the 1990s," Review of Financial Economics, Elsevier, Elsevier, vol. 13(3), pages 231-243.
  5. Mark, Nelson C. & Moh, Young-Kyu, 2007. "Official interventions and the forward premium anomaly," Journal of Empirical Finance, Elsevier, Elsevier, vol. 14(4), pages 499-522, September.
  6. Young-Kyu Moh & Nelson C. Mark, 2004. "Official Interventions and Occasional Violations of Uncovered Interest Parity in the Dollar-DM Market," Econometric Society 2004 Far Eastern Meetings, Econometric Society 762, Econometric Society.
  7. William P. Osterberg & Rebecca Wetmore Humes, 1995. "More on the differences between reported and actual U.S. central bank foreign exchange intervention," Working Paper 9501, Federal Reserve Bank of Cleveland.
  8. M. Frenkel & C. Pierdzionc & G. Stadtmann, 2001. "The foreign exchange market interventions of the European Central Bank," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, Banca Nazionale del Lavoro, vol. 54(218), pages 249-287.
  9. M. Frenkel & C. Pierdzionc & G. Stadtmann, 2001. "The foreign exchange market interventions of the European Central Bank," BNL Quarterly Review, Banca Nazionale del Lavoro, Banca Nazionale del Lavoro, vol. 54(218), pages 249-287.
  10. Michael D. Bordo & Owen F. Humpage & Anna J. Schwartz, 2009. "A brief empirical history of U.S. foreign-exchange intervention: 1973-1995," Working Paper 0903, Federal Reserve Bank of Cleveland.
  11. Adam Geršl, 2006. "Testing the Effectiveness of the Czech National Bank’s Foreign-Exchange Interventions," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, Charles University Prague, Faculty of Social Sciences, vol. 56(09-10), pages 398-415, September.
  12. Pasquariello, Paolo, 2007. "Informative trading or just costly noise? An analysis of Central Bank interventions," Journal of Financial Markets, Elsevier, Elsevier, vol. 10(2), pages 107-143, May.
  13. Richard T. Baillie & William P. Osterberg, 1998. "Central bank intervention and overnight uncovered interest rate parity," Working Paper 9823, Federal Reserve Bank of Cleveland.

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