Central bank interventions and exchange rate band regimes

This paper presents an endogenous switching regression model for the exchan ge rate process where the switch is defined by the central bank criteria fu nctions for intervening. We study the signal effect of interventions on the exchange rate using Norwegian daily data on official interventions. We fir st find that interventions seemed to have been more effective in moving the exchange rate in the expected ('desired') direction in the regime when the exchange rate was kept away from the edges of the band. This type of inter vention regime also reduces significantly the conditional volatility of the exchange rate. Thus, when the exchange rate was near the weakest edge of t he currency band, its conditional variance was significantly larger than wh en it was moving around its central parity. Finally, we show that in order to obtain consistent estimates, intervention variables cannot enter as exog enous variables in the conditional mean (or conditional variance) of the ex change rate. (C) 2001 Elsevier Science Ltd. All rights reserved.