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Is Sterilized Foreign Exchange Intervention Effective After All? An Event Study Approach

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  • Rasmus Fatum
  • Michael M. Hutchison

Abstract

Central banks actively engage in sterilized foreign exchange market intervention despite numerous empirical studies indicating that these operations do not systematically affect the exchange rate. Are these policies misguided and central bankers irrational? Or is evidence showing the effectiveness of sterilized intervention being overlooked? This paper argues the latter, providing evidence on the effectiveness of sterilized intervention using an event study approach linking intervention with systematic exchange rate changes. We argue that this is an important methodological innovation since studies using time-series techniques are limited by the nature of the data: intense and sporadic bursts of intervention activity juxtaposed against exchange rates that change almost continuously on a daily basis. The event study framework used in standard finance studies, by contrast, is ideally suited to this circumstance. Focusing on daily US official intervention operations, we identify separate intervention “episodes” and analyze the subsequent effect on the exchange rate. Using the matched-sample mean test and the non-parametric sign test of the median, we find strong evidence that sterilized intervention systemically affects the exchange rate. These results are especially strong when episodes are distinguished by the intervention currency, the form of intervention (sales or purchases of foreign exchange), and exchange rate developments immediately prior to the intervention activity.

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Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 99-09.

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Handle: RePEc:kud:epruwp:99-09

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  1. Graciela Kaminsky & Karen K. Lewis, 1993. "Does Foreign Exchange Intervention Signal Future Monetary Policy?," NBER Working Papers 4298, National Bureau of Economic Research, Inc.
  2. A. Craig MacKinlay, 1997. "Event Studies in Economics and Finance," Journal of Economic Literature, American Economic Association, vol. 35(1), pages 13-39, March.
  3. Fatum, Rasmus, 2000. "On the effectiveness of sterilized foreign exchange intervention," Working Paper Series 0010, European Central Bank.
  4. Dominguez, Kathryn M & Frankel, Jeffrey A, 1993. "Does Foreign-Exchange Intervention Matter? The Portfolio Effect," American Economic Review, American Economic Association, vol. 83(5), pages 1356-69, December.
  5. Lewis, Karen K, 1995. "Are Foreign Exchange Intervention and Monetary Policy Related, and Does It Really Matter?," The Journal of Business, University of Chicago Press, vol. 68(2), pages 185-214, April.
  6. Bonser-Neal, Catherine & Tanner, Glenn, 1996. "Central bank intervention and the volatility of foreign exchange rates: evidence from the options market," Journal of International Money and Finance, Elsevier, vol. 15(6), pages 853-878, December.
  7. Campbell, Cynthia J. & Wesley, Charles E., 1993. "Measuring security price performance using daily NASDAQ returns," Journal of Financial Economics, Elsevier, vol. 33(1), pages 73-92, February.
  8. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  9. Owen F. Humpage, 1996. "U.S. intervention: assessing the probability of success," Working Paper 9608, Federal Reserve Bank of Cleveland.
  10. Edison, H.J., 1993. "The Effectiveness of Central-Bank Intervention: A Survey of the Litterature after 1982," Princeton Studies in International Economics 18, International Economics Section, Departement of Economics Princeton University,.
  11. 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.
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