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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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  1. Nicholas Barberis & Andrei Shleifer & Robert W. Vishny, 1997. "A Model of Investor Sentiment," NBER Working Papers 5926, National Bureau of Economic Research, Inc.
  2. Giancarlo Corsetti & Amil Dasgupta & Stephen Morris & Hyun Song Shin, 2004. "Does One Soros Make a Difference? A Theory of Currency Crises with Large and Small Traders," Review of Economic Studies, Oxford University Press, vol. 71(1), pages 87-113.
  3. Corsetti, Giancarlo & Guimaraes, Bernardo & Roubini, Nouriel, 2006. "International lending of last resort and moral hazard: A model of IMF's catalytic finance," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 441-471, April.
  4. Corrado, L. & Marcus Miller & Lei Zhang, 2002. "Exchange Rate Monitoring Bands: Theory and Policy," Cambridge Working Papers in Economics 0209, Faculty of Economics, University of Cambridge.
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  8. Mark P. Taylor & Lucio Sarno, 2001. "Official Intervention in the Foreign Exchange Market: Is It Effective and, If So, How Does It Work?," Journal of Economic Literature, American Economic Association, vol. 39(3), pages 839-868, September.
  9. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2006. "Signaling in a Global Game: Coordination and Policy Traps," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 452-484, June.
  10. Krugman, Paul & Miller, Marcus, 1992. "Why Have a Target Zone?," CEPR Discussion Papers 718, C.E.P.R. Discussion Papers.
  11. David M. Frankel & Stephen Morris & Ady Pauzner, 2001. "Equilibrium Selection in Global Games with Strategic Complementarities," Cowles Foundation Discussion Papers 1336, Cowles Foundation for Research in Economics, Yale University.
  12. Paul De Grauwe & Pablo Rovira Kaltwasser, 2007. "Modeling Optimism and Pessimism in the Foreign Exchange Market," CESifo Working Paper Series 1962, CESifo Group Munich.
  13. John Williamson, 1999. "Crawling Bands or Monitoring Bands: How to Manage Exchange Rates in a World of Capital Mobility," Policy Briefs PB99-03, Peterson Institute for International Economics.
  14. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-97, June.
  15. Jeffrey A. Frankel & C. Fred Bergsten & Michael L. Mussa, 1994. "Exchange Rate Policy," NBER Chapters, in: American Economic Policy in the 1980s, pages 293-366 National Bureau of Economic Research, Inc.
  16. Prat, Andrea & Dasgupta, Amil, 2006. "Financial equilibrium with career concerns," Theoretical Economics, Econometric Society, vol. 1(1), pages 67-93, March.
  17. Sanford J. Grossman & Zhongquan Zhou, 1993. "Optimal Investment Strategies For Controlling Drawdowns," Mathematical Finance, Wiley Blackwell, vol. 3(3), pages 241-276.
  18. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  19. Dasgupta, Amil & Prat, Andrea, 2005. "Asset Price Dynamics When Traders Care About Reputation," CEPR Discussion Papers 5372, C.E.P.R. Discussion Papers.
  20. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2003. "Coordination and Policy Traps," NBER Working Papers 9767, National Bureau of Economic Research, Inc.
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