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Market-reaction-adjusted optimal central bank intervention policy in a forex market with jumps

Author

Listed:
  • Sandun Perera

    (University of Michigan–Flint)

  • Winston Buckley

    (Bentley University)

  • Hongwei Long

    (Florida Atlantic University)

Abstract

Impulse control with random reaction periods (ICRRP) is used to derive a country’s optimal foreign exchange (forex) rate intervention policy when the forex market reacts to the interventions. This paper extends the previous work on ICRRP by incorporating a multi-dimensional jump diffusion process to model the state dynamics, and hence, enhance the viability of the extant model for applications. Furthermore, we employ a novel minimum cost operator that simplifies the computations of the optimal solutions. Finally, we demonstrate the efficacy of our framework by finding a market-reaction-adjusted optimal central bank intervention (CBI) policy for a country. Our numerical results suggests that market reactions and the jumps in the forex market are complements when the reactions increase the forex rate volatility; otherwise, they are substitutes.

Suggested Citation

  • Sandun Perera & Winston Buckley & Hongwei Long, 2018. "Market-reaction-adjusted optimal central bank intervention policy in a forex market with jumps," Annals of Operations Research, Springer, vol. 262(1), pages 213-238, March.
    • Handle: RePEc:spr:annopr:v:262:y:2018:i:1:d:10.1007_s10479-016-2297-y
    DOI: 10.1007/s10479-016-2297-y
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