Optimal Central Bank Intervention in the Foreign Exchange Market

Cadenillas, Abel; Zapatero, Fernando

doi:10.1006/jeth.1999.2523

Cited by 127 publications

(99 citation statements)

References 24 publications

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“…This multi-dimensional control problem has been proposed and studied in various forms in different context of risk management, from optimal cash management [6] to inventory controls [14,13,34,33]. More recent papers in the literature of mathematical finance include those on transaction cost in portfolio management [2,19,20,9,25,28], insurance models [16,4], liquidity risk [22,3], optimal control of exchange rates [17,26,5], and finally real options [35,23].…”

Section: Dx(t) = µ(X(t))dt + σ(X(t))dw (T) +mentioning

confidence: 99%

Smooth Fit Principle for Impulse Control of Multidimensional Diffusion Processes

Guo¹,

Wu²

2009

SIAM J. Control Optim.

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Section: Dx(t) = µ(X(t))dt + σ(X(t))dw (T) +mentioning

confidence: 99%

Smooth Fit Principle for Impulse Control of Multidimensional Diffusion Processes

Guo¹,

Wu²

2009

SIAM J. Control Optim.

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“…Because we also have a control whose application changes the drift and the diffusion coefficient of the controlled process, the resulting mathematical problem becomes a mixed regular-impulse control problem (e.g., Cadenillas et al [14]). In the case of a pure impulse control, the optimal policy is of the   , , , a A B b type, where the four parameters used to construct the optimal control must be computed as a part of a solution to the problem (see Cadenillas and Zapatero [15], Constantinides and Richard [10], Harrison and Taylor [16], and Paulsen [17]). Parameters a and b represent the levels at which the intervention (application of impulses) must be made, whereas A and B stand for the positions that the controlled process must be in after the intervention is made.…”

Section: The Hjb Equation In the Continuation Regionmentioning

confidence: 99%

Mixed Band Control of Mutual Proportional Reinsurance

Taksar¹,

Liu²,

Yuan³

2013

JMF

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In this paper, we investigate the optimization of mutual proportional reinsurance-a mutual reserve system that is intended for the collective reinsurance needs of homogeneous mutual members, such as P&I Clubs in marine mutual insurance and reserve banks in the US Federal Reserve, where a mutual member is both an insurer and an insured. Compared to general (non-mutual) insurance models, which involve one-sided impulse control (i.e., either downside or upside impulse) of the underlying insurance reserve process that is required to be positive, a mutual insurance differs in allowing two-sided impulse control (i.e., both downside and upside impulse), coupled with the classical proportional control of reinsurance. We prove that a special band-type impulse control   , , , a A B b a with and a A coupled with a proportional reinsurance policy (classical control), is optimal when the objective is to minimize the total maintenance cost. That is, when the reserve position reaches a lower boundary of , the reserve should immediately be raised to level A; when the reserve reaches an upper boundary of b, it should immediately be reduced to a level B. An interesting finding produced by the study reported in this paper is that there exists a situation such that if the upside fixed cost is relatively large in comparison to a finite threshold, then the optimal band control is reduced to a downside only (i.e., dividend payment only) control in the form of   , B b 0, 0; with 0 a A   . In this case, it is optimal for the mutual insurance firm to go bankrupt as soon as its reserve level reaches zero, rather than to jump restart by calling for additional contingent funds. This finding partially explains why many mutual insurance companies, that were once quite popular in the financial markets, are either disappeared or converted to non-mutual ones.

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“…In the monopolist case, at each t the dealer sets quotes that maximize the expected profit per unit time, i.e., that maximize the expected cash inflows from selling shares minus the expected cash outflows from buying shares to and from investors (and maybe the CB). 9 Many competing dealers instead set the same quotes such that the expected profit for the representative MM is equal to zero, by virtue of Bertrand competition. 10 In order to isolate the impact of interventions on quotes and spreads, we assume that the MMs do not face any order processing costs or inventory control, i.e., that our stylized currency market is frictionless.…”

Section: Dealersmentioning

confidence: 99%

Central bank intervention and the intraday process of price formation in the currency markets

Pasquariello

2010

Journal of International Money and Finance

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We study the impact of sterilized Central Bank interventions on the microstructure of currency markets. We analyze their major channels of effectiveness, imperfect substitutability and signaling, in a model of sequential trading in which the stylized monetary authority is a rational, but not necessarily profit-maximizing player. In such a setting, and consistent with available empirical evidence, we find that intervention has endogenous long-lived effects on quotes when informative about policy objectives and fundamentals, or when the threat of future actions by the Central Bank is significant and credible, for these circumstances lead uninformed investors or dealers to a permanent revision in their beliefs. Portfolio balance effects of such transactions are instead short-lived, because of trading occurring sequentially and not because of high asset substitutability, as often argued in the literature. We also find that a monetary authority attempting to lean against the wind or to chase the trend of the domestic currency is generally more successful when dealers compete against each other for the incoming trades. Intuitively, competition induces the dealers to pass all revenues or losses they expect from trading with the Central Bank onto the population of investors. This is accomplished by greater, and generally asymmetric, revisions of their bid and ask quotes. The resulting equilibrium process of intraday price formation and bid-ask spreads are shown to depend crucially on the degree of market power held by the forex dealers, on the sign and magnitude of announced and realized interventions, on the perceived likelihood of a future intervention to occur, and on the transparency of the order flow induced by the intervention.

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Optimal Central Bank Intervention in the Foreign Exchange Market

Cited by 127 publications

References 24 publications

Smooth Fit Principle for Impulse Control of Multidimensional Diffusion Processes

Smooth Fit Principle for Impulse Control of Multidimensional Diffusion Processes

Mixed Band Control of Mutual Proportional Reinsurance

Central bank intervention and the intraday process of price formation in the currency markets

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