The Price Impact of Currency Trades: Implications for Intervention
Martin D. D. Evans*
Richard K. Lyons
This draft: 30th June 2000
Abstract
Central-bank intervention always introduces asymmetric information. There are no plausible, common-knowledge alternatives, regardless of intervention type ( announced vs. unannounced), and regardless of efficacy channel (., port- folio vs information). This paper recasts intervention analysis into a framework of asymmetric information. This allows us to address long-standing questions in a new way. We offer four main results. First, we find evidence of imperfect sub- stitutability, a necessary condition for the efficacy of the portfolio channel. Sec- ond, we find evidence of an operative signaling channel. Third, we establish a lower bound on the unconditional price impact of sterilized trades: 5 basis points per $100 million. Fourth, we provide an explicit answer to an important unan- swered question: “When should Central Banks intervene?”
Correspondence Richard K. Lyons Haas School of Business, UC Berkeley Berkeley, CA 94720-1900 Tel: 510-642-1059, Fax: 510-643-1420 ******@ /~lyons
* Respective affiliations are etown University and NBER, and UC Berkeley and NBER. We thank the following for ments: Rich Clarida. Lyons thanks the National Science Foundation for financial assistance. The Price Impact of Currency Trades: Implications for Intervention
Central Bank intervention in the Foreign Exchange market always introduces asymmetric information. There are no plausible, common-knowledge alternatives, regard- less of intervention type (. announced vs. unannounced), and regardless of efficacy channel (., portfolio vs. information). This paper recasts intervention analysis into a framework of asymmetric information. In doing so, we bring new perspective to two long- sta
