Strategic Trading When Central Bank Intervention Is Predictable

Market prices are noisy signals of economic fundamentals. In a two-period model, we show that if the central bank uses market prices as guidance for intervention, large, strategic investors who benefit from high prices would depress market prices to induce a market-supportive intervention. Stronger anticipated interventions lead to deeper price depressions preintervention and sharper price reversals post- intervention. The central bank intervention harms strategic investors even though it is the investors who tried to mislead the central bank. The model predicts a V-shaped price pattern around central bank interventions, consistent with recent evidence. (JEL G14, G18)

Evolving Efficiency of Exchange Rate Movement: An Evidence from Indian Foreign Exchange Market

This study empirically verifies the evolving and time-varying efficiency of Indian foreign exchange market using the framework of adaptive market hypothesis (AMH). Whether market efficiency is time varying or static, and if time varying, identification of possible events causing such time-varying efficiency are the two major agenda of this study. We employ a set of recent methods which are robust and possess stronger power properties. Moreover, we follow a fixed-length rolling window approach to explore time-varying nature of market efficiency and to avoid data-snooping bias. Our overall findings suggest that market efficiency is not an all-or-nothing condition; it varies over time. We also find that episodes of efficiency coincide with emergence of major events and market microstructure issues. Particularly, changes in exchange rate regime, financial turbulence, major central bank interventions and trade volume are the prominent causes for time-varying efficiency in INR–USD exchange rate. The evidence of swing between efficiency and inefficiency can prompt currency traders to exploit arbitrage opportunities that emerge with different market conditions.

Predictability of Indian Exchange Rates

In this paper we determine the extent of predictability of India’s major spot exchange rates by using the Lyapunov exponent. We first determine whether the series is fractal (self-similar) in nature. If it is indeed so, then next we determine whether the underlying dynamics of the system is deterministic or stochastic. If the dynamics is found to be deterministic then we calculate the Largest Lyapunov Exponent (LLE) to determine whether the series has deterministic chaos. Finally we use the inverse of the Lyapunov exponent to estimate the time period for which out of sample predictions for the series make sense. We find that India’s major spot exchange rates are: a) fractal in nature, b) chaotic with a high embedding dimension and c) The inverse of the LLE gives us a time frame in which any meaningful predictions can be made. These results are interpreted in two ways. First, exploiting the efficient market interpretation of randomness we conclude that since available information is fairly rapidly internalized, chaotic behaviour is mainly due to the unforeseen nature of the pool of new information affecting the systems at such short intervals of time. Second, anti-cyclical central bank interventions are conjectured to be the source of determinism in otherwise almost random movements.

Stochastic impulse control of exchange rates with Freidlin–Wentzell perturbations

This paper pioneers a Freidlin–Wentzell approach to stochastic impulse control of exchange rates when the central bank desires to maintain a target zone. Pressure to stimulate the economy forces the bank to implement diffusion monetary policy involving Freidlin–Wentzell perturbations indexed by a parameter ε∈ [0,1]. If ε=0, the policy keeps exchange rates in the target zone for all times t≥0. When ε>0, exchange rates continually exit the target zone almost surely, triggering central bank interventions which force currencies back into the zone or abandonment of all targets. Interventions and target zone deviations are costly, motivating the bank to minimize these joint costs for any ε∈ [0,1]. We prove convergence of the value functions as ε→0 achieving a value function approximation for small ε. Via sample path analysis and cost function bounds, intervention followed by target zone abandonment emerges as the optimal policy.

Rebound Effects of Exchange Rate and Central Bank Interventions in Selected ECOWAS Countries

This study examines the exchange rate rebound effects of the Central Bank intervention in the selected ECOWAS economies. An empirical understanding of these effects is very important to trade adjustment as well as the macroeconomic stability in these countries. Using the panel data modelling framework, the study finds that the impact of the Central Bank intervention on exchange rate is insignificant and it does not lead to the exchange rate rebound. In addition, money supply as well as monetary policy rate implemented by the monetary authorities significantly influences the level of exchange rate in a positive direction.