Heterogeneous Market‐Making in Foreign Exchange Markets: Evidence from Individual Bank Responses to Central Bank Interventions

Abstract

Using high-frequency data this article provides evidence that, on average, central bank interventions lead to increased volatility and a widening of bid-ask spreads in the intra-day market for foreign exchange. The results also show that there is dispersion in the bid-ask spread revisions posted by individual banks in response to the central bank entering the market. The findings are consistent with predictions from standard models of market microstructure with heterogeneous agents and have implications for the market power of central banks as well as the payoff generated by trading large amounts of international reserves. Copyright 2007 The Ohio State University.

Are the Intraday Effects of Central Bank Intervention on Exchange Rate Spreads Asymmetric and State Dependent?

“…It is, therefore, difficult to compare our findings to other studies. Nevertheless, it is noteworthy that our results show that the intraday effects of intervention on spreads are asymmetric, thereby contrasting the results of studies by Chari (2007) and Naranjo and Nimalendran (2000) that, in the context of intervention in the JPY/USD and the DEM/USD markets, respectively, show that intervention, on average, increases the spread. Our finding that the influence of interventions is state dependent is, however, consistent with the results of Dominguez (2003).…”

“…See Humpage (2003) and Neely (2005) for broad surveys of the intervention literature. 2 Microstructure based contributions include Naranjo and Nimalendran (2000), Dominguez (2003), and Chari (2007). The first study analyses the effects of intervention on exchange rate spreads using official daily intervention data, the two more recent studies use time-stamped newswire reports of intervention to analyze the effects of intervention on the first two moments of the exchange rate and the exchange rate spread, respectively.…”

Exchange rate management in emerging markets: Intervention via an electronic limit order book

“…There are hardly any papers examining this relation as appropriate data are generally unavailable. The studies of Chari (2007) and Pasquariello (2007) rely on quotes which are tentatively wider than effective spreads and do not necessarily reflect market conditions as precisely. Both studies find that spread increases after interventions, indicating that a volatility reducing effect may be counter balanced by higher transaction costs for customers (see Naranjo and Nimalendran, 2000, for daily data).…”

Price Discovery in Brazilian FX Markets

“…Echavarría et al (428) also report a significant price effect of pre-announced interventions and capital controls on the Colombian spot exchange rate. However, the intervention effect is not limited to first order impacts, as Chari (2007) finds. According to the author, central bank interventions lead, on average, to widening spreads and increasing levels of volatility.…”