The advantage to hiding one's hand: Speculation and central bank intervention in the foreign exchange market
Using a portfolio balance model of exchange rate determination, this paper develops a theoretical explanation of why central banks do not make precise announcements of their exchange rate targets. In foreign exchange markets, where it is common knowledge that the central bank intervenes to stabilize the spot exchange rate around some target level, foreign exchange traders can exploit this fact to earn speculative profits from the central bank: this may cause the bank's reserves to fall to dangerous levels. We show that if the central bank is imprecise about its exchange rate targeting, it can use this informational advantage not only to reduce its reserve losses, but also to extract all relevant `fundamental' information from the traders. The imprecision, however, cannot be too large. There exist circumstances where the central bank finds it advantageous to reduce the market's ex ante uncertainty about the exchange rate target.
(This abstract was borrowed from another version of this item.)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Judd, Kenneth L., 1985. "The law of large numbers with a continuum of IID random variables," Journal of Economic Theory, Elsevier, vol. 35(1), pages 19-25, February.
- Laffont, Jean-Jacques & Maskin, Eric S, 1990. "The Efficient Market Hypothesis and Insider Trading on the Stock Market," Journal of Political Economy, University of Chicago Press, vol. 98(1), pages 70-93, February.
- Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
- Bhattacharya, Utpal & Spiegel, Matthew, 1991.
"Insiders, Outsiders, and Market Breakdowns,"
Review of Financial Studies,
Society for Financial Studies, vol. 4(2), pages 255-282.
- Bhattacharya, U. & Spiegel, M., 1989. "Insiders, Outsiders And Market Breakdowns," Papers fb-_89-20, Columbia - Graduate School of Business.
- Milgrom, Paul & Stokey, Nancy, 1982. "Information, trade and common knowledge," Journal of Economic Theory, Elsevier, vol. 26(1), pages 17-27, February.
- Paul Milgrom & Nancy L.Stokey, 1979. "Information, Trade, and Common Knowledge," Discussion Papers 377R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Stephen A. Ross, 1977. "The Determination of Financial Structure: The Incentive-Signalling Approach," Bell Journal of Economics, The RAND Corporation, vol. 8(1), pages 23-40, Spring.
- Ausubel, Lawrence M, 1990. "Insider Trading in a Rational Expectations Economy," American Economic Review, American Economic Association, vol. 80(5), pages 1022-1041, December.
- Dominguez, Kathryn Mary, 1990. "Market responses to coordinated central bank intervention," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 32(1), pages 121-163, January.
- Kathryn M. Dominguez, 1989. "Market Responses To Coordinated Central Bank Intervention," NBER Working Papers 3192, National Bureau of Economic Research, Inc.
- Dominguez, K.M., 1989. "Market Responses To Coordinated Central Bank Intervention," Papers 179d, Harvard - J.F. Kennedy School of Government.
- Maurice Obstfeld, 1990. "The Effectiveness of Foreign-Exchange Intervention: Recent Experience, 1985- 1988," NBER Chapters,in: International Policy Coordination and Exchange Rate Fluctuations, pages 197-246 National Bureau of Economic Research, Inc.
- Grossman, Sanford J, 1976. "On the Efficiency of Competitive Stock Markets Where Trades Have Diverse Information," Journal of Finance, American Finance Association, vol. 31(2), pages 573-585, May.
- Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
- 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 1356-1369, December.
- Sanford J. Grossman, 1977. "The Existence of Futures Markets, Noisy Rational Expectations and Informational Externalities," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 431-449.
- Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
- Stein, Jeremy C, 1989. "Cheap Talk and the Fed: A Theory of Imprecise Policy Announcements," American Economic Review, American Economic Association, vol. 79(1), pages 32-42, March.
- Donald B. Adams & Dale W. Henderson, 1983. "Definition and measurement of exchange market intervention," Staff Studies 126, Board of Governors of the Federal Reserve System (U.S.). Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:eee:moneco:v:39:y:1997:i:2:p:251-277. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.