Central bank intervention and exchange rate volatility: Evidence from Japan using realized volatility

Abstract

This paper presents new empirical evidence on the effectiveness of Bank of Japan's foreign exchange interventions on the daily realized volatility of USD/JPY exchange rates using high frequency data. Following Huang and Tauchen (2005) and Shephard (2004, 2006), we use bi-power variation to decompose daily realized volatility into two components: the smooth persistent and the discontinuous jump components. We model exchange rate returns, the different components of realized volatility and the central bank intervention using a system of simultaneous equations. We find strong support that interventions by Bank of Japan had increased both the continuous and the jump components of daily realized volatility. This suggests that the interventions by Bank of Japan had increased market volatility which not only caused short-lived positive jumps but were also persistent over time. We did not find any evidence that interventions were effective in influencing the exchange rate returns for the entire sample period. Keywords AbstractThis paper presents new empirical evidence on the effectiveness of Bank of Japan's foreign exchange interventions on the daily realized volatility of USD/JPY exchange rates using high frequency data. Following Huang and Tauchen (2005) and Shephard (2004, 2006), we use bi-power variation to decompose daily realized volatility into two components: the smooth persistent and the discontinuous jump components. We model exchange rate returns, the different components of realized volatility and the central bank intervention using a system of simultaneous equations. We find strong support that interventions by Bank of Japan had increased both the continuous and the jump components of daily realized volatility. This suggests that the interventions by Bank of Japan had increased market volatility which not only caused short-lived positive jumps but were also persistent over time. We did not find any evidence that interventions were effective in influencing the exchange rate returns for the entire sample period.

Economic and political effects on currency clustering dynamics

“…In the literature, the effects of CBIs on foreign exchange rates have been studied by various techniques, particularly focusing on volatility of exchange rates. These techniques include GARCH type models (Almekinders and Eijffinger 1996, Baillie and Osterberg 1997b,a, Dominguez 1998, Beine et al 2002, implied volatility estimation of currency options (Bonser-Neal andTanner 1996, Dominguez 1998), regime-switching analysis of mean and variance of exchange rates (Beine et al 2003), realized volatility estimation (Dominguez 2006, Beine et al 2009, Cheng et al 2013, time series study of news reports (Fatum and Hutchison 2002), and event study of CBIs (Fatum and Hutchison 2002, Fatum 2008.…”

Exchange Rate and Central Bank Intervention

“…Exchange rate and central bank intervention is an important topic in the exchange rate determination [1][2][3][4]. Exchange rates are volatile after the breakdown of the Bretton Woods system of fixed exchange rate in the year 1973.…”

“…Central bank intervention in the exchange rate market may want to accrue international reserves to enhance the fundamental of the economy [5]. There are two important issues related to the exchange rate intervention, namely the effectiveness of central bank intervention and the success of central bank in maintaining the exchange rate and in reducing exchange rate volatility [1,4,6]. In general, the literature of exchange rate and central bank intervention is inconclusive on the impact of central bank intervention.…”

“…In general, the literature of exchange rate and central bank intervention is inconclusive on the impact of central bank intervention. Most studies conclude that central bank intervention tends to increase exchange rate volatility [4].…”

“…Furthermore, small frequent intervention reduces exchange rate volatility whereas large frequent intervention increases exchange rate volatility. Cheng et al [4] examine the effectiveness of central bank intervention in the exchange rate market in Japan on the volatilities of the USD/JPY and Deutsche Mark (EURO) against the JPY exchange rates. The data are daily five minutes quotes for the period from April 1, 1991 to July 31, 2006.…”