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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 influences 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 i) that in extreme circumstances large scale foreign exchange intervention can have destabilizing effects for the functioning of FX markets and ii) that the route chosen for the implementation of official intervention has important implications for its impact on exchange rates and on market conditions. JEL Classification: D82, G14, G15

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Paper provided by European Central Bank in its series Working Paper Series with number 0629.

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Date of creation: May 2006
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Handle: RePEc:ecb:ecbwps:20060629
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  1. António Afonso & Vítor Gaspar, 2006. "Excess burden and the cost of inefficiency in public services provision," Working Papers Department of Economics 2006/05, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
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  13. 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.
  14. Richard K. Lyons, 1993. "Tests of Microstructural Hypotheses in the Foreign Exchange Market," NBER Working Papers 4471, National Bureau of Economic Research, Inc.
  15. Bhattacharya, Utpal & Weller, Paul, 1992. "The Advantage to Hiding One's Hand: Speculation and Central Bank Intervention in the Foreign Exchange Market," CEPR Discussion Papers 737, C.E.P.R. Discussion Papers.
  16. 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.
  17. Payne, Richard & Vitale, Paolo, 2003. "A transaction level study of the effects of central bank intervention on exchange rates," Journal of International Economics, Elsevier, vol. 61(2), pages 331-352, December.
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  23. 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.
  24. Breedon, Francis & Vitale, Paolo, 2004. "An Empirical Study of Liquidity and Information Effects of Order Flow on Exchange Rates," CEPR Discussion Papers 4586, C.E.P.R. Discussion Papers.
  25. Graciela L. Kaminsky & Karen K. Lewis, 1993. "Does foreign exchange intervention signal future monetary policy?," Finance and Economics Discussion Series 93-1, Board of Governors of the Federal Reserve System (U.S.).
  26. Paolo Vitale, 2007. "A Guided Tour Of The Market Microstructure Approach To Exchange Rate Determination," Journal of Economic Surveys, Wiley Blackwell, vol. 21(5), pages 903-934, December.
  27. Welz, Peter, 2006. "Assessing predetermined expectations in the standard sticky-price model: a Bayesian approach," Working Paper Series 0621, European Central Bank.
  28. 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.
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  30. Campolmi, Alessia & Faia, Ester, 2006. "Cyclical inflation divergence and different labor market institutions in the EMU," Working Paper Series 0619, European Central Bank.
  31. 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.
  32. Tsutomu Watanabe, 1992. "The signaling effect of foreign exchange intervention: the case of Japan," Proceedings, Federal Reserve Bank of San Francisco, pages 258-286.
  33. 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.
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