Strategic Trading When Central Bank Intervention Is Predictable

Forthcoming in Review of Asset Pricing Studies

31 Pages Posted: 9 Jun 2020 Last revised: 19 Mar 2021

See all articles by Liyan Yang

Liyan Yang

University of Toronto - Rotman School of Management

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: March 19, 2021

Abstract

Market prices are noisy signals of economic fundamentals. In a two-period model, we show that if the central bank uses market prices as guidance for intervention, large strategic investors who benefit from high prices would depress market prices to induce a market-supportive intervention. Stronger anticipated interventions lead to deeper price depressions pre-intervention and sharper price reversals post-intervention. The presence of central bank intervention harms strategic investors even though it is the investors who try to mislead the central bank. The model predicts a V-shaped price pattern around central bank interventions, consistent with recent empirical evidence.

Keywords: central bank intervention, strategic trading, price reversal, price volatility

JEL Classification: G14, G18

Suggested Citation

Yang, Liyan and Zhu, Haoxiang, Strategic Trading When Central Bank Intervention Is Predictable (March 19, 2021). Forthcoming in Review of Asset Pricing Studies, Available at SSRN: https://ssrn.com/abstract=3580352 or http://dx.doi.org/10.2139/ssrn.3580352

Liyan Yang (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street E62-623
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~zhuh

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

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