How are Exchange Rates Managed? Evidence of Error-Correction Around a Reference

20 Pages Posted: 13 May 2012 Last revised: 14 May 2012

See all articles by Kang Chen

Kang Chen

National University of Singapore (NUS) - Lee Kuan Yew School of Public Policy

Chang Yee Kwan

Independent

Date Written: March 7, 2012

Abstract

In managed floats, central banks often intervene in the foreign exchange market to obtain politically desirable exchange rates. How this is done has remained totally opaque although central banks are likely to adopt a satisfying rather than optimizing strategy since they need to intervene frequently in a timely manner under incomplete information. In this paper, we propose a simple exchange rate management rule that balances the amount of variation between currency pairs around a reference rate. We test out this rule using the Chinese Yuan as a case study before extending the study to 9 other currencies. Empirical results are consistent with the hypothesis that central banks follow the error correction rule in exchange rate management.

Keywords: Exchange rate policy, Managed float, Error correction model

JEL Classification: F31, O24, P21 

Suggested Citation

Chen, Kang and Kwan, Chang Yee, How are Exchange Rates Managed? Evidence of Error-Correction Around a Reference (March 7, 2012). Lee Kuan Yew School of Public Policy Research Paper No. LKYSPP 12-09. Available at SSRN: https://ssrn.com/abstract=2056183 or http://dx.doi.org/10.2139/ssrn.2056183

Kang Chen (Contact Author)

National University of Singapore (NUS) - Lee Kuan Yew School of Public Policy ( email )

Singapore 117591
Singapore

Chang Yee Kwan

Independent ( email )

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