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Option prices, exchange market intervention, and the higher moment expectations channel: a user’s guide

Author

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  • Gabriele Galati
  • Patrick C. Higgins
  • Owen F. Humpage
  • William R. Melick

Abstract

A vast literature on the effects of sterilized intervention by the monetary authorities in the foreign exchange markets concludes that intervention systematically moves the spot exchange rate only if it is publicly announced, coordinated across countries, and consistent with the underlying stance of fiscal and monetary policy. Over the past fifteen years, researchers have also attempted to determine if intervention has any effects on the dispersion and directionality of market views concerning the future exchange rate. These studies usually focus on the variance around the expected future exchange rate—the second moment. In this paper we demonstrate how to use over-the-counter option prices to recover the risk-neutral probability density function (PDF) for the future exchange rate. Using the yen/dollar exchange rate as an example, we calculate measures of dispersion and directionality, such as variance and skewness, from estimated PDFs to test whether intervention by the Japanese Ministry of Finance had any impact on the higher moments of the exchange rate. We find little or no systematic effect, consistent with the findings of the literature on the spot rate as Japanese intervention during the period 1996-2004 was not publicly announced, rarely coordinated across countries and, in hindsight, probably inconsistent with the underlying stance of monetary policy.

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  • Gabriele Galati & Patrick C. Higgins & Owen F. Humpage & William R. Melick, 2006. "Option prices, exchange market intervention, and the higher moment expectations channel: a user’s guide," Working Paper 0618, Federal Reserve Bank of Cleveland.
  • Handle: RePEc:fip:fedcwp:0618
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    Cited by:

    1. Michel Beine & Oscar Bernal & Jean-Yves Gnabo & Christelle Lecourt, 2007. "Intervention Policy of the BoJ: a Unified Approach," LSF Research Working Paper Series 07-19, Luxembourg School of Finance, University of Luxembourg.
    2. Hutchison, Michael & Sushko, Vladyslav, 2013. "Impact of macro-economic surprises on carry trade activity," Journal of Banking & Finance, Elsevier, vol. 37(4), pages 1133-1147.
    3. Beine, Michel & Bernal, Oscar & Gnabo, Jean-Yves & Lecourt, Christelle, 2009. "Intervention policy of the BoJ: A unified approach," Journal of Banking & Finance, Elsevier, vol. 33(5), pages 904-913, May.
    4. Jukka Sihvonen & Sami Vähämaa, 2014. "Forward‐Looking Monetary Policy Rules and Option‐Implied Interest Rate Expectations," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 34(4), pages 346-373, April.
    5. Rasmus Fatum, 2009. "Official Japanese Intervention in the JPY/USD Exchange Rate Market: Is It Effective, and through Which Channel Does It Work?," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 27(1), pages 75-98, November.
    6. Huang, Alex YiHou & Peng, Sheng-Pen & Li, Fangjhy & Ke, Ching-Jie, 2011. "Volatility forecasting of exchange rate by quantile regression," International Review of Economics & Finance, Elsevier, vol. 20(4), pages 591-606, October.
    7. Yushi Yoshida & Jan C. Rülke, 2009. "On-Going versus Completed Interventions and Yen/Dollar Expectations - Evidence from Disaggregated Survey Data," Discussion Papers 35, Kyushu Sangyo University, Faculty of Economics, revised Dec 2009.

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    Keywords

    Options (Finance) ; Foreign exchange administration;

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