How To Intervene In Fx Market: Market Microstructure Approach
This paper proposes a market microstructure model of FX intervention to analyze the relationship between central bank intervention and the characteristics of the foreign exchange market. The implication of our model is that the characteristic of the exchange rate movements around central bank intervention is determined by portfolio managers¡¯ trading intensity and their boundary weights on the fundamentalist¡¯s view, market-makers¡¯ price adjustment speed and their speculative trading intensity. When the portfolio managers¡¯ trading intensity is low (thin market), central bank must operate heavy interventions to move spot exchange rate toward a target level. As the portfolio managers¡¯ boundary weight (minimum or maximum) on the fundamentalist¡¯s view increases, the influence of intervention increases. When the market-makers¡¯ price adjustment speed is fast, central bank must operate small interventions. Overall, this paper suggests that central banks need to have superior information on the characteristics of the foreign exchange market at the time the intervention operations are performed.
Volume (Year): 32 (2007)
Issue (Month): 1 (June)
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