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The Forward Exchange Market, Speculation, and Exchange Market Intervention

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  • Jonathan Eaton
  • Stephen J. Turnovsky

Abstract

This paper develops a stochastic equilibrium model of an open economy incorporating speculation in the forward exchange market. The model is used to examine two issues. The first is the role of speculation in stabilizing the economy against stochastic disturbances. Much risk averse speculation stabilizes domestic income against disturbances in the domestic bond market and forward exchange marketbut exacerbates the effect of foreign disturbances. Speculation may dampen or augment the effect of money market and output supply disturbances depending upon the share of foreign bonds in total wealthand the interest elasticity of bond demand. The second issue that the model addresses is the role of the forward market in stabilization policy. Forward market intervention (or its equivalent in this model,sterilized spot market intervention) does not provide monetary authorities additional leverage in stabilizing income beyond unsterilized spot market intervention. Intervention rules based on reactions to both the forward and the spot exchange rates, however, can outper-form intervention policies responding to the spot rate alone,regardless of the market in which intervention occurs.

Suggested Citation

  • Jonathan Eaton & Stephen J. Turnovsky, 1983. "The Forward Exchange Market, Speculation, and Exchange Market Intervention," NBER Working Papers 1138, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:1138
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    References listed on IDEAS

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    Cited by:

    1. Weymark, Diana N, 1997. "Measuring the degree of exchange market intervention in a small open economy," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 55-79, February.
    2. Patricio Mujica, 1988. "Políticas de Tipo de Cambio: Un Modelo de Tres Países," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 25(75), pages 197-214.
    3. Weymark, Diana N., 1995. "Estimating exchange market pressure and the degree of exchange market intervention for Canada," Journal of International Economics, Elsevier, vol. 39(3-4), pages 273-295, November.
    4. Eaton, Jonathan, 1985. "Optimal and time consistent exchange-rate management in an overlapping-generations economy," Journal of International Money and Finance, Elsevier, vol. 4(1), pages 83-100, March.
    5. Suh, Sangwon & Zapatero, Fernando, 2008. "A class of quadratic options for exchange rate stabilization," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3478-3501, November.
    6. Zapatero, Fernando & Reverter, Luis F., 2003. "Exchange rate intervention with options," Journal of International Money and Finance, Elsevier, vol. 22(2), pages 289-306, April.
    7. Hui-Kuan Tseng, 1998. "Exchange Rate Variability and Exchange Market Intervention: Spot vs. Forward," International Economic Journal, Taylor & Francis Journals, vol. 12(2), pages 1-16.
    8. Lin, Hwan C., 2008. "Forward-rate target zones and exchange rate dynamics," Journal of International Money and Finance, Elsevier, vol. 27(5), pages 831-846, September.
    9. Nikhil Patel & Paolo Cavllino, 2019. "FX intervention: goals, strategies and tactics," BIS Papers chapters, in: Bank for International Settlements (ed.), Reserve management and FX intervention, volume 104, pages 25-44, Bank for International Settlements.

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