Monitoring Bands and Monitoring Rules: How Currency Intervention Can Change Market Composition
18 Pages Posted: 12 Feb 2007
Date Written: February 2007
In this paper we show how trading rules can generate excess volatility in the exchange rate through repeated entry and exit of currency bears and bulls. This is something of a caricature: but it allows us to show that offcial action can have self-fulfilling effects as market composition shifts in ways that support offcial stabilization. Intervention if and when the rate moves outside what Williamson has labelled 'monitoring bands' can reduce market volatility as the effect of the policy is to select endogenously traders from the market whose expectations match offcial intervention.
Keywords: Monitoring Rules, Monitoring Band, Bear and Bull Traders, Excess Volatility, Central Bank Volatility
JEL Classification: D52, F31, G12
Suggested Citation: Suggested Citation