Sterilized foreign exchange market interventions have been suspected of being inefficient by many empirical studies, but they are plagued by endogeneity problems. To solve the problems, this paper identifies a system that depicts interactions between the interventions and the foreign exchange rate. The model shows that the interventions are effective when the interventions alter the market participants' conditional expectations of the rate without decreasing the conditional variances. This paper estimates Markov-switching type policy reaction functions by conditional MLE, and market demand/supply curves by IV estimation with generated regressors. The empirical results verify that the interventions of the Bank of Korea from 2001 to 2002 were indeed effective.
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Paper provided by Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington in its series Caepr Working Papers with number
2007-004.
Find related papers by JEL classification: F31 - International Economics - - International Finance - - - Foreign Exchange E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
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