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Foreign Exchange Market Intervention in Two Small Open Economies: The Canadian and Australian Experience

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  • Jeff M. Rogers
  • Pierre Siklos

    (Wilfred Laurier University)

Abstract

This paper provides and empirical assessment of the effectiveness of foreign exchange intervention in two small open economies. Specifically, we examine the intervention practices of the Bank of Canada (BoC) and the Reserve Bank of Australia (RBA) for a sample of daily data spanning the period from 1989 to the end of 1997. Our analysis suggests that both central bank intervene in foreign exchange markets in response to excessive exchange rate volatility and uncertainty. Volatility is measured using the implied volatility of foreign currency futures options and uncertainty is proxied using the kurtosis of the implied risk-neutral probability density functions. The latter are derived using the implied volatility of options on foreign currency futures. We also examine whether the introduction of inflation targets affected the success of interventions. in the foreign exchange market. Unlike other studies in this area we also explicitly consider the role of commodity futures prices which turn out to be important in understanding the effectiveness of intervention. We find that central bank intervention in the foreign exchange amrket was largely unsuccessful in both countries though volatility and kurtosis were modestly affected.

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Bibliographic Info

Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 57.

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Date of creation: 01 Jun 2001
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Handle: RePEc:uts:rpaper:57

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  1. Dominguez, Kathryn M., 1998. "Central bank intervention and exchange rate volatility1," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 161-190, February.
  2. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, October.
  3. Almekinders, Geert J & Eijffinger, Sylvester C W, 1994. "Daily Bundesbank and Federal Reserve Interventions: Are They a Reaction to Changes in the Level and Volatility of the DM/$-Rate?," Empirical Economics, Springer, vol. 19(1), pages 111-30.
  4. Hung, Juann H, 1997. "Intervention strategies and exchange rate volatility: a noise trading perspective," Journal of International Money and Finance, Elsevier, vol. 16(5), pages 779-793, September.
  5. Neil, Beattie & Fillion, Jean-Fran├žois, 1999. "An Intraday Analysis of the Effectiveness of Foreign Exchange Intervention," Working Papers 99-4, Bank of Canada.
  6. Frank Campbell & Eleanor Lewis, 1998. "What Moves Yields in Australia?," RBA Research Discussion Papers rdp9808, Reserve Bank of Australia.
  7. Kim, Suk-Joong & Kortian, Tro & Sheen, Jeffrey, 2000. "Central bank intervention and exchange rate volatility -- Australian evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 10(3-4), pages 381-405, December.
  8. Almekinders, G.J. & Eijffinger, S.C.W., 1996. "A friction model of daily Bundesbank and Federal Reserve intervention," Open Access publications from Tilburg University urn:nbn:nl:ui:12-73527, Tilburg University.
  9. Agathe Cote, . "Exchange Rate Volatility and Trade: A Survey," Working Papers 94-5, Bank of Canada.
  10. Haan, Wouter J. den & Spear, Scott A., 1998. "Volatility clustering in real interest rates Theory and evidence," Journal of Monetary Economics, Elsevier, vol. 41(3), pages 431-453, May.
  11. Llad Phillips & John Pippenger, 1993. "Stabilization of the Canadian Dollar: 1975-1986," Canadian Journal of Economics, Canadian Economics Association, vol. 26(2), pages 416-46, May.
  12. Siklos, Pierre L, 2000. "Is the MCI a Useful Signal of Monetary Policy Conditions? An Empirical Investigation," International Finance, Wiley Blackwell, vol. 3(3), pages 413-37, November.
  13. Catherine Bonser-Neal, 1996. "Does central bank intervention stabilize foreign exchange rates?," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 43-57.
  14. 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 2690, C.E.P.R. Discussion Papers.
  15. Michael P. Leahy & Charles P. Thomas, 1996. "The sovereignty option: the Quebec referendum and market views on the Canadian dollar," International Finance Discussion Papers 555, Board of Governors of the Federal Reserve System (U.S.).
  16. Weymark, Diana N, 1997. "Measuring the degree of exchange market intervention in a small open economy," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 55-79, February.
  17. repec:fth:sydnec:99-05 is not listed on IDEAS
  18. Baillie, Richard T. & Osterberg, William P., 1997. "Why do central banks intervene?," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 909-919, December.
  19. Robert A. Amano & Tony S. Wirjanto, 1994. "A Further Analysis of Exchange Rate Targeting in Canada," Econometrics 9406001, EconWPA, revised 22 Jun 1994.
  20. Murray, John, 1999. "Why Canada Needs a Flexible Exchange Rate," Working Papers 99-12, Bank of Canada.
  21. Weymark, Diana N., 1995. "Estimating exchange market pressure and the degree of exchange market intervention for Canada," Journal of International Economics, Elsevier, vol. 39(3-4), pages 273-295, November.
  22. Kim, Suk-Joong & Sheen, Jeffrey, 2002. "The determinants of foreign exchange intervention by central banks: evidence from Australia," Journal of International Money and Finance, Elsevier, vol. 21(5), pages 619-649, October.
  23. Pierre L. Siklos, 1999. "Inflation-target design: changing inflation performance and persistence in industrial countries," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 46-58.
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