The impact of federal reserve intervention on exchange rate volatility: evidence from the futures markets
The collapse of Bretton Woods or the fixed exchange rate system in 1973, along with the coinciding growth in global trade, and greater mobility of capital have all contributed to an increase in exchange rate volatility. Concerns about exchange rate levels and volatility have prompted central banks to actively intervene in foreign currency markets from time to time. This paper presents an empirical investigation of the relationship between central bank intervention actions and currency volatility. This paper is distinguished from earlier studies by employing expectation-based information contained in the currency futures prices to estimate conditional volatility in the USUS$/DM and US$/¥ returns, and by incorporating the simultaneity of the relationship between the Fed's intervention operation and exchange rate volatility into the model. Results suggest a lack of relationship between Fed's intervention activity and the US$/DM conditional volatility during the 1985-1993 period. However, Fed intervention is associated with negative changes in the US$/¥ volatility during the 1985 to 1993 period as a whole, and specifically during the 1 January, 1985 to 21 February, 1987 Plaza period and the 21 February, 1987 to 31 December, 1989 Louvre period. Furthermore, the results document a strong feedback effect (bidirectional causality) between US$/¥ volatility and intervention actions. During the post-Louvre period (1 January, 1990 to 31 December, 1993), it is found that the Fed's intervention led to an increase in the volatility of US$¥, without a corresponding feedback relationship. The sign reversal is attributed to the breakdown of the Louvre Accord and the mixed nature of monetary policy signals given during this period.
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