Occasional Interventions to Target Rates with a Foreign Exchange Application
Karen K. Lewis
This paper develops a framework for analyzing the effects upon rates when
occasional central bank interventions try to keep rates near target
levels. Interestingly, the threat of capital gains or losses induced by
this stochastic intervention policy helps contain rates within implicit
boundaries around the target level. More importantly, this intervention
policy concentrates observations of the exchange rate around the target
level and away from the implicit bands. In Monte Carlo simulations,
sufficiently tight distributions for intervention around the target level
imply that the bands are never reached in practice. As an application,
the model is empirically evaluated using exchange rate and intervention
observations following the 1987 Louvre accord. In these estimates, the
probability of intervention never exceeds more than about .5 while the
range of observed exchange rates remain far away from the implicit bands
where the probability of intervention is one.
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