The Effects of Central Bank Invervention on the Volatility of Exchange Rates: Evidence from the Options Market

The flexible exchange rate period officially began in 1973 with the complete col-lapse of the Bretton Woods agreements. It ushered in a period of intense exchange rate volatility. Since the excessive variability often uffe cted the economy, central ha-nks began to intervene to support the dollar in the foreign exchange market. An analysis of the effects of central hank interventions on the exchange market is pres-ented. There have been many contradictory study results as to whether central bank interventions decrease or increase volatilities of exchange rates. We examine the in-tervention effeats on the changes in the implied volatilities of the DM and YEN exchange rates in the foreign currency options market during the post-Louvre period. Our main conclusions derived from our research arc as f011ow: The effects of interventions of the Federal Reserve, Bundesbank, and Bank of Japan on changes in the implied volatilities of the DM and the YEN exchange rate were also positive and significant in the .foreign currency options market. In other words, the inter-vention policies increased the magnitude of volatilities in the options market during the post-Louvre period. In this sense, if the intervention purpose was to decrease the volatilities, we can conclude that the intervention policies were unsuccessful attaining their goals during the post-Louvre period,