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Bulls, Bears and Excess Volatility: can currency intervention help?

  • Corrado, L.
  • Miller, M.
  • Zhang, L.

Asset mis-pricing may reflect investor psychology, with excess volatility arising 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-sterilised 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 sterilised intervention may also play a coordinating role.

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File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe0708.pdf
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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0708.

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Length: 29
Date of creation: Jan 2007
Date of revision:
Handle: RePEc:cam:camdae:0708
Note: Ec
Contact details of provider: Web page: http://www.econ.cam.ac.uk/index.htm

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  18. Giancarlo Corsetti & Bernardo Guimaraes & Nouriel Roubini, 2003. "International Lending of Last Resort and Moral Hazard: A Model of IMF's Catalytic Finance," NBER Working Papers 10125, National Bureau of Economic Research, Inc.
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