Skip to main content
SpringerLink
Log in

Central Bank Intervention and Heterogeneous Exchange Rate Expectations: Evidence from the Daily DEM/US-Dollar Exchange Rate

  • Published:
Open Economies Review Aims and scope Submit manuscript

Abstract

In this paper we propose a generalisation of the noise trader transmission mechanism to examine the impact of central bank intervention on exchange rates. Within a heterogeneous expectation exchange rate model intervention operations are supposed to provide support for chartist or fundamentalist forecasts, which forces portfolio managers to adjust their foreign currency positions. The empirical examination of the hypothesis is done by applying a Markov regime-switching approach to daily DEM/US-dollar exchange rates and intervention data of the Deutsche Bundesbank and the Federal Reserve from 1979 to 1992. It is shown that chartist’s profits rose whenever these central banks intervened on the foreign exchange market. This is not true for those who follow a fundamentalist approach.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • Baillie, R. and W. Osterberg (1997a) “Central Bank Intervention and Risk in the Forward Market.” Journal of International Economics 43:483–497.

    Google Scholar 

  • Baillie, R. and W. Osterberg (1997b) “Why Do Central Banks Intervene?” Journal of International Money and Finance 16:909–919.

    Google Scholar 

  • Brock, W. and C. Hommes (1998) “Heterogeneous Beliefs and Routes to Chaos in a Simple Asset Pricing Model.” Journal of Economic Dynamics Control 22:1235–1274.

    Google Scholar 

  • Clarida, R., L. Sarno, M. Taylor, and G. Valente (2001) “The Out-of-Sample Success of Term Structure Models as Exchange Rate Predictors: A Step Beyond.” Mimeo.

  • DeLong, J.B., A. Shleifer, L. Summers, and R. Waldman (1990) “Noise Trader Risk in Financial Markets.” Journal of Political Economy 98:703–738.

    Google Scholar 

  • De Grauwe, P. (1994) “Exchange Rates in Search of Fundamental Variables.” (CEPR Discussion Paper) 1073.

  • De Grauwe, P. and H. Dewachter (1993) “A Chaotic Model of the Exchange Rate: The Role of Fundamentalists and Chartists.” Open Economies Review 4:351–379.

    Google Scholar 

  • Dewachter, H. (2001) “Can Markov Switching Models Replicate Chartist Profits in the Foreign Exchange Market?” Journal of International Money and Finance 20:25–41.

    Google Scholar 

  • Dominguez, K. (1998) “Central Bank Intervention and Exchange Rate Volatility.”Journal of International Money and Finance 17:161–190.

    Google Scholar 

  • Dominguez, K. and J. Frankel (1993a) “Does Foreign-Exchange Intervention Matter? The Portfolio Effect.” American Economic Review 83:1356–1369.

    Google Scholar 

  • Dominguez, K. and J. Frankel (1993b) Does Foreign-Exchange Intervention Work? Washington, D.C: Institute for International Economics.

    Google Scholar 

  • Dooley, M. and J. Shafer (1983) “Analysis of Short-Run Exchange Rate Behavior: March 1979 to November 1981.” In D. Bigman and T. Taya (eds.), Exchange Rate and Trade Instability: Causes, Consequences and Remedies. Ballinger Cambridge.

    Google Scholar 

  • Engel, Ch. (1994) “Can the Markov Switching Model Forecast Exchange Rates?” Journal of International Economics 36:151–165.

    Google Scholar 

  • Engel, Ch. and J. Hamilton (1990) “Long Swings in the Dollar: Are They in the Data and Do Markets Know It?” American Economic Review 80:689–713.

    Google Scholar 

  • Farmer, D. and S. Joshi (2002) “The Price Dynamics of Common Trading Strategies.” Journal of Economic Behavior and Organization, 49:149–171.

    Google Scholar 

  • Fatum, R. and M. Hutchison (2002) “ECB Foreign Exchange Intervention and the Euro: Institutional Framework, News, and Intervention.” Open Economies Review 13:413–425.

    Google Scholar 

  • Frankel, J. and K. Froot (1986) “Understanding the US Dollar in the Eighties: The Expectations of Chartists and Fundamentalists.” The Economic Record 62:24–38.

    Google Scholar 

  • Hamilton, J. (1989) “A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle.” Econometrica 57:357–384.

    MATH  Google Scholar 

  • Hommes, C. (2001) “Financial Markets as Nonlinear Adaptive Evolutionary Systems.” Quantitative Finance 1:149–167.

    Google Scholar 

  • Hung, J. (1997) “Intervention Strategies and Exchange Rate Volatility: A Noise Trading Perspective.” Journal of International Money and Finance 16:779–793.

    Google Scholar 

  • Kaminsky, G. and K. Lewis (1996) “Does Foreign Exchange Intervention Signal Future Monetary Policy?” Journal of Monetary Economics 37:285–312.

    Google Scholar 

  • Klein, M. (1993) “The Accuracy of Reports of Foreign Exchange Intervention.” Journal of International Money and Finance 12:644–653.

    Google Scholar 

  • LeBaron, B. (1999) “Technical Trading Rule Profitability and Foreign Exchange Intervention.” Journal of International Economics 49:125–143.

    Google Scholar 

  • Lee, Ch., K. Gleason, and I. Mathur (2001) “Trading Rule Profits in Latin American Currency Spot Rates.” International Review of Fin. Analysis 10:135–156.

    Google Scholar 

  • Lewis, K. (1989) “Changing Beliefs and Systematic Rational Forecast Errors with Evidence from Foreign Exchange.” American Economic Review 79:621–636.

    Google Scholar 

  • Lux, T. (1995) “Herd Behaviour, Bubbles and Crashes.” Economic Journal 105:881–896.

    Google Scholar 

  • Mussa, M. (1981) The Role of Official Intervention. Group of Thirty, New York.

    Google Scholar 

  • Neely, C. (1997) “Technical Analysis in the Foreign Exchange Market: A Layman’s Guide.” Fed. R. Bank of St. Louis Review 79(5):23–38.

    Google Scholar 

  • Neely, C. and P. Weller (2001) “Technical Analysis and Central Bank Intervention.” Journal of International Money and Finance 20:949–970.

    Google Scholar 

  • Press, W., S. Flannery, S. Teukolsky, and W. Vettering (1988) Numerical Recipes in C. New York: Cambridge University Press.

    Google Scholar 

  • Sarno, L. and M. Taylor (2001) “Official Intervention in the Foreign Exchange Market: Is It Effective and, If So, How Does It Work?” Journal of Economic Literature 39:839–868.

    Google Scholar 

  • Takagi, S. (1991) “Exchange Rate Expectations, A Survey of Survey Studies.” IMF Staff Papers 38:156–183.

    Google Scholar 

  • Taylor, M. and H. Allen (1992) “The Use of Technical Analysis in the Foreign Exchange Market.” Journal of International Money and Finance 11:304–314.

    Google Scholar 

  • Taylor, M. and D. Peel (2000) “Nonlinear Adjustment, Long Run Equilibrium and Exchange Rate Fundamentals.” Journal of International Money and Finance 19:33–53.

    Google Scholar 

  • Taylor, M., D. Peel, and L. Sarno (2001) “Nonlinear Adjustment in Real Exchange Rates: Torwards a Solution to the Purchasing Power Parity Puzzles.” International Economic Review 6:19–42.

    Google Scholar 

  • Vigfusson, R. (1997) “Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach.” International Journal of Financial Economics 2:291–305.

    Google Scholar 

  • Westerhoff, F. (2003) “Central Bank Intervention and Feedback Traders.” Journal of International Financial Markets, Institutions and Money13:419–427.

    Google Scholar 

  • White, H. (1982) “Maximum Likelihood Estimation of Misspecified Models.” Econometrica 50:1–25.

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. International Business School, Brandeis University, Waltham, MA, 02454, USA

    Stefan Reitz

Authors
  1. Stefan Reitz
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Stefan Reitz.

Additional information

JEL Classification Numbers: F31, C32, E58, G15

Rights and permissions

Reprints and permissions

About this article

Cite this article

Reitz, S. Central Bank Intervention and Heterogeneous Exchange Rate Expectations: Evidence from the Daily DEM/US-Dollar Exchange Rate. Open Econ Rev 16, 33–50 (2005). https://doi.org/10.1007/s11079-005-5331-2

Download citation

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11079-005-5331-2

Keywords

Search

Navigation