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

Author

Listed:
  • Gabriele Galati

    (Monetary and Economic Department, Bank for International Settlements, Switzerland)

  • Patrick Higgins

    (Research Department, Federal Reserve Bank of Cleveland, USA)

  • Owen Humpage

    (Research Department, Federal Reserve Bank of Cleveland, USA)

  • William Melick

    (Department of Economics, Kenyon College, USA)

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 15 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 during the period 1996-2004 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 was not publicly announced prior to August 2000, and since that time only publicly announced after the fact, over the past 10 years rarely coordinated across countries and, in hindsight, probably inconsistent with the underlying stance of monetary policy. Copyright © 2007 John Wiley & Sons, Ltd.

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  • Gabriele Galati & Patrick Higgins & Owen Humpage & William Melick, 2007. "Option prices, exchange market intervention, and the higher moment expectations channel: a user's guide," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 12(2), pages 225-247.
  • Handle: RePEc:ijf:ijfiec:v:12:y:2007:i:2:p:225-247
    DOI: 10.1002/ijfe.325
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    Cited by:

    1. 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.
    2. 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.
    3. 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.
    4. He Li & Zhixiang Yu & Chuanjie Zhang & Zhuang Zhang, 2017. "Determination of China’s foreign exchange intervention: evidence from the Yuan/Dollar market," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 34(1), pages 62-81, March.
    5. 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.
    6. 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.
    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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