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Bulls, bears and excess volatility: can currency intervention help?

  • Luisa Corrado

    (Faculty of Economics, University of Cambridge and University of Rome, Tor Vergata, Italy)

  • Marcus Miller

    (Department of Economics, University of Warwick and CEPR, UK)

  • Lei Zhang

    (Department of Economics, University of Warwick, UK)

Asset mis-pricing may reflect investor psychology; and excess volatility can arise from switches of sentiment. For a floating exchange rate where fundamentals follow a random walk, we show that excess volatility can be generated by the repeated entry and exit of currency 'bulls' and 'bears' with switches driven by 'draw-down' trading rules. We argue that non-sterilized intervention-in support of 'monitoring band'-can reduce excess volatility by coordinating beliefs in line with policy. Strategic complementarity in the foreign exchange market suggests that sterilized intervention may also play a coordinating role. Copyright © 2007 John Wiley & Sons, Ltd.

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Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 12 (2007)
Issue (Month): 2 ()
Pages: 261-272

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Handle: RePEc:ijf:ijfiec:v:12:y:2007:i:2:p:261-272
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