Heterogeneous behaviours and the effectiveness of central bank intervention in the yen/dollar exchange market

Chung-Wei Kao and Jer-Yuh Wan

Applied Financial Economics, 2012, vol. 22, issue 12, 967-975

Abstract: A nonlinear heterogeneous agent model is applied to the yen/dollar exchange rate market to discuss the channels of an effective central bank intervention. The existence of two hypothetical channels proposed by Hung (1997) and Taylor (2004, 2005) are tested and confirmed. Evidence shows heterogeneous agents are active in the yen/dollar market where the stabilizing force from the fundamentalists declines in large misalignments. Central bank intervention is effective in arousing the trend-reversing sentiment among chartists to prevent market from explosion. The intervention is also effective in strengthening fundamentalists’ confidence that the market will move toward its theoretical equilibrium. The intervention has significant effects on fundamentalists’ confidence, regardless of whether the forecasting method relies on Purchasing Power Parity (PPP) only or on a PPP plus Uncovered Interest rate Parity (UIP) condition. The interest rate differential can affect the exchange rate changes through influencing demand orders of the short-run fundamentalists.

Date: 2012
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DOI: 10.1080/09603107.2011.633887

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