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A Market Microstructure Analysis of Foreign Exchange Intervention

  • Vitale, Paolo

We formulate a market microstructure model of exchange determination we employ to investigate the impact of foreign exchange intervention on exchange rates and on foreign exchange (FX) market conditions. With our formulation we show i) how foreign exchange intervention in°uences exchange rates via both a portfolio-balance and a signalling channel and ii) derive a series of testable implications which are coherent with a large body of empirical research. Our investigation also proposes some normative recommendations, as we show that central bank intervention can be destabilizing for the functioning of FX markets and that the route chosen for the implementation of o±cial intervention has important implications for its impact on exchange rates and on market conditions.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5468.

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Date of creation: Jan 2006
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Handle: RePEc:cpr:ceprdp:5468
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  1. Kaminsky, Graciela L. & Lewis, Karen K., 1996. "Does foreign exchange intervention signal future monetary policy?," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 285-312, April.
  2. Fatás, Antonio & Mihov, Ilian & Rose, Andrew K., 2006. "Quantitative goals for monetary policy," Working Paper Series 0615, European Central Bank.
  3. Charles Engel & Kenneth D. West, 2005. "Exchange Rates and Fundamentals," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 485-517, June.
  4. Breedon, Francis & Vitale, Paolo, 2004. "An empirical study of liquidity and information effects of order flow on exchange rates," Working Paper Series 0424, European Central Bank.
  5. Kenneth A. Froot & Tarun Ramadorai, 2005. "Currency Returns, Intrinsic Value, and Institutional-Investor Flows," Journal of Finance, American Finance Association, vol. 60(3), pages 1535-1566, 06.
  6. Richard Payne & Paolo Vitale, 2002. "A transaction level study of the effects of central bank intervention on exchange rates," LSE Research Online Documents on Economics 25040, London School of Economics and Political Science, LSE Library.
  7. Christopher J. Neely, 2001. "The practice of central bank intervention: looking under the hood," Review, Federal Reserve Bank of St. Louis, issue May, pages 1-10.
  8. Lewis, Karen K, 1995. "Are Foreign Exchange Intervention and Monetary Policy Related, and Does It Really Matter?," The Journal of Business, University of Chicago Press, vol. 68(2), pages 185-214, April.
  9. Michael Ehrmann, 2011. "Inflation Developments and Perceptions after the Euro Cash Changeover," German Economic Review, Verein für Socialpolitik, vol. 12(1), pages 33-58, 02.
  10. Afonso, António & Gaspar, Vítor, 2006. "Excess burden and the cost of inefficiency in public services provision," Working Paper Series 0601, European Central Bank.
  11. Hoidal Bjonnes, Geir & Rime, Dagfinn, 2003. "Dealer Behavior and Trading Systems in Foreign Exchange Markets," SIFR Research Report Series 17, Institute for Financial Research.
  12. Tsutomu Watanabe, 1992. "The signaling effect of foreign exchange intervention: the case of Japan," Proceedings, Federal Reserve Bank of San Francisco, pages 258-286.
  13. Kathryn Dominguez & Jeffrey A. Frankel, 1990. "Does Foreign Exchange Intervention Work?," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 16.
  14. Martin D. D. Evans & Richard K. Lyons, 2002. "Order Flow and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 110(1), pages 170-180, February.
  15. Payne, Richard, 2003. "Informed trade in spot foreign exchange markets: an empirical investigation," Journal of International Economics, Elsevier, vol. 61(2), pages 307-329, December.
  16. Marie Diron, 2008. "Short-term forecasts of euro area real GDP growth: an assessment of real-time performance based on vintage data," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 27(5), pages 371-390.
  17. Eric van Wincoop & Philippe Bacchetta, 2003. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," NBER Working Papers 9498, National Bureau of Economic Research, Inc.
  18. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2003. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," American Economic Review, American Economic Association, vol. 93(1), pages 38-62, March.
  19. Michael W. Klein & Eric S. Rosengren, 1991. "Foreign exchange intervention as a signal of monetary policy," New England Economic Review, Federal Reserve Bank of Boston, issue May, pages 39-50.
  20. Popper, Helen & Montgomery, John D., 2001. "Information sharing and central bank intervention in the foreign exchange market," Journal of International Economics, Elsevier, vol. 55(2), pages 295-316, December.
  21. Vitale, Paolo, 2004. "A Guided Tour of the Market Microstructure Approach to Exchange Rate Determination," CEPR Discussion Papers 4530, C.E.P.R. Discussion Papers.
  22. Rich Lyons & Martin Evans, 2004. "A New Micro Model of Exchange Rate Dynamics," Econometric Society 2004 North American Winter Meetings 622, Econometric Society.
  23. Lyons, Richard K., 1995. "Tests of microstructural hypotheses in the foreign exchange market," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 321-351.
  24. Hendry, David F & Hubrich, Kirstin, 2006. "Forecasting Economic Aggregates by Disaggregates," CEPR Discussion Papers 5485, C.E.P.R. Discussion Papers.
  25. Bhattacharya, Utpal & Weller, Paul, 1997. "The advantage to hiding one's hand: Speculation and central bank intervention in the foreign exchange market," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 251-277, July.
  26. Welz, Peter, 2006. "Assessing predetermined expectations in the standard sticky-price model: a Bayesian approach," Working Paper Series 0621, European Central Bank.
  27. Giannone, Domenico & Reichlin, Lucrezia, 2006. "Trends and cycles in the euro area: how much heterogeneity and should we worry about it?," Working Paper Series 0595, European Central Bank.
  28. Tsutomu Watanabe, 1992. "The signaling effect of foreign exchange intervention: the case of Japan," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  29. Sweeney, Richard J., 1997. "Do central banks lose on foreign-exchange intervention? A review article," Journal of Banking & Finance, Elsevier, vol. 21(11-12), pages 1667-1684, December.
  30. Livio Stracca, 2007. "A Speed Limit Monetary Policy Rule for the Euro Area," International Finance, Wiley Blackwell, vol. 10(1), pages 21-41, 03.
  31. Ehrmann, Michael & Fratzscher, Marcel, 2006. "Global financial transmission of monetary policy shocks," Working Paper Series 0616, European Central Bank.
  32. Vitale, Paolo, 1999. "Sterilised central bank intervention in the foreign exchange market," Journal of International Economics, Elsevier, vol. 49(2), pages 245-267, December.
  33. Campolmi, Alessia & Faia, Ester, 2006. "Cyclical inflation divergence and different labor market institutions in the EMU," Working Paper Series 0619, European Central Bank.
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