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Intervention strategies and exchange rate volatility: a noise trading perspective

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  • Juann H. Hung
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    Abstract

    This paper estimates and explains the impact of U.S. sterilized intervention on exchange rate volatility. We find that U.S. intervention reduced both yen/dollar and DM/dollar exchange rate volatilities during 1985-86, but increased them during 1987-89. These results make sense in a noise trading framework where the effectiveness of sterilized intervention may depend critically on the shrewdness of intervention strategies. Depending on circumstances, central banks may use noise trading channels through covert intervention, or activate signaling channels through overt intervention. The intervention exchange rate volatility relationship may change as intervention strategies adjust to differing circumstances.

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    File URL: http://www.newyorkfed.org/research/staff_reports/research_papers/9515.html
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    Bibliographic Info

    Paper provided by Federal Reserve Bank of New York in its series Research Paper with number 9515.

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    Date of creation: 1995
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    Handle: RePEc:fip:fednrp:9515

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    Keywords: Foreign exchange ; Open market operations ; Investments;

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    1. Richard K. Lyons, 1986. "Tests of the foreign exchange risk premium using the expected second moments implied by option pricing," International Finance Discussion Papers 290, Board of Governors of the Federal Reserve System (U.S.).
    2. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-53, March.
    3. Klein, Michael W., 1993. "The accuracy of reports of foreign exchange intervention," Journal of International Money and Finance, Elsevier, vol. 12(6), pages 644-653, December.
    4. Rogoff, Kenneth, 1984. "On the effects of sterilized intervention : An analysis of weekly data," Journal of Monetary Economics, Elsevier, vol. 14(2), pages 133-150, September.
    5. Owen F. Humpage, 1991. "Central-bank intervention: recent literature, continuing controversy," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 12-26.
    6. Michael W. Klein & Eric S. Rosengren, 1991. "Foreign exchange intervention as a signal of monetary policy," New England Economic Review, Federal Reserve Bank of Boston, issue May, pages 39-50.
    7. Jeffrey A. Frankel & Kenneth A. Froot, 1987. "Using Survey Data to Test Some Standard Propositions Regarding Exchange Rate Expectations," NBER Working Papers 1672, National Bureau of Economic Research, Inc.
    8. Garman, Mark B. & Kohlhagen, Steven W., 1983. "Foreign currency option values," Journal of International Money and Finance, Elsevier, vol. 2(3), pages 231-237, December.
    9. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Cowles Foundation Discussion Papers 719R, Cowles Foundation for Research in Economics, Yale University.
    10. Jeffrey A. Frankel & Kenneth A. Froot, 1987. "The Dollar as an Irrational Speculative Bubble: A Tale of Fundamentalisists," NBER Working Papers 1854, National Bureau of Economic Research, Inc.
    11. Levich, Richard M. & Thomas, Lee III, 1993. "The significance of technical trading-rule profits in the foreign exchange market: a bootstrap approach," Journal of International Money and Finance, Elsevier, vol. 12(5), pages 451-474, October.
    12. Loopesko, Bonnie E., 1984. "Relationships among exchange rates, intervention, and interest rates: An empirical investigation," Journal of International Money and Finance, Elsevier, vol. 3(3), pages 257-277, December.
    13. Shleifer, Andrei & Summers, Lawrence H, 1990. "The Noise Trader Approach to Finance," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 19-33, Spring.
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