Learning About Intervention Target Zones
This paper provides a framework for evaluating how market participants' beliefs about foreign exchange target zones change as they learn about central bank intervention policy. In order to examine this behavior, we first generalize the standard target zone model to allow for intra-marginal intervention. Intra-marginal intervention implies that the position of market participants' beliefs about the target zone can be determined from their beliefs about the likelihood of intervention. As an application of this model, we estimate a probability of intervention model using daily exchange rates and market observations of central bank interventions following the Louvre Accord. Interestingly, even over this relatively stable Louvre Accord period, we find that the market's views of intervention target zones would have varied quite a bit over time.
Document Object Identifier (DOI): 10.3386/w3674
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