The impact of FX central bank intervention in a noise trading framework

Abstract

a b s t r a c tIn this paper, we analyse the effectiveness of the direct central bank interventions using a new effectiveness criterion. To this aim, we investigate the effects of central bank interventions (CBI) in a noise trading model with chartists and fundamentalists. We first estimate a model in which chartists extrapolate past returns and fundamentalists forecast a mean reverting dynamics of the exchange rate towards a fundamental value. Then, we investigate the role of central bank interventions for explaining the switching properties between the two types of agents. We find evidence that in the medium run, interventions increase the proportion of fundamentalists and therefore exert some stabilizing influence on the exchange rate.

Should central bankers talk to the foreign exchange markets?

“…When the central banks step into the market, this might lead FX traders to co-ordinate their view on the direction of the future changes in the exchange rate, which in turn may lead to successful operations (in terms of exchange rate level at least). Supportive empirical evidence of such a channel has been provided in the context of chartistsfundamentalists switching regime models by a couple of some authors (Reitz and Taylor, 2006;Beine et al, 2005). Beine et al (2005) show that it is particularly relevant for co-ordinated operations since the presence of the two central banks in the market tends to strengthen the signal embodied in the interventions.…”

“…Supportive empirical evidence of such a channel has been provided in the context of chartistsfundamentalists switching regime models by a couple of some authors (Reitz and Taylor, 2006;Beine et al, 2005). Beine et al (2005) show that it is particularly relevant for co-ordinated operations since the presence of the two central banks in the market tends to strengthen the signal embodied in the interventions. 36 In order to save space, we focus only on the comparison between the model including the size of interventions and the parsimonious model shown in Tables 4 and 5. Since the theoretical background of the role of statements relies on the signalling channel, it makes sense to look at a possible conditional role of statements and interventions with respect to the degree of exchange rate misalignment.…”

Exchange rate expectations of chartists and fundamentalists

“…When, however, exchange rate misalignment becomes more and more obvious, the relative attractiveness of fundamentalism increases and more market participants follow fundamentals. This mechanism limits the power of chartism and reduces the deviation of exchange rates from their fundamental equilibrium rate; this also provides a motivation for foreign exchange interventions (e.g., Beine, De Grauwe, and Grimaldi, 2009). As long as exchange rates are not obviously misaligned such that there is less certainty about their true fundamental rate, chartists are relatively stronger.…”

Investment intensity of currencies and the random walk hypothesis: Cross-currency evidence

“…Additionally, central bank intervention can be a factor affecting the exchange rate behavior (e.g., Beine et al, 2009). But since our sample is comprised of those currencies with floating exchange rate regimes, central bank intervention is not likely to have a major impact on the exchange rate behavior.…”