Central Bank Intervention and Exchange Rate Volatility: Evidence from Japan Using Realized Volatility

This paper presents new empirical evidence on the effectiveness of Bank of Japan's foreign exchange interventions on the daily realized volatility of USD/JPY exchange rates using high frequency data. Following Huang and Tauchen (2005) and Barndorff-Nielsen and Shephard (2004, 2006), we use bi-power variation to decompose daily realized volatility into two components: the smooth persistent and the discontinuous jump components. We model exchange rate returns, the different components of realized volatility and the central bank intervention using a system of simultaneous equations. We find strong support that interventions by Bank of Japan had increased both the continuous and the jump components of daily realized volatility. This suggests that the interventions by Bank of Japan had increased market volatility which not only caused short-lived positive jumps but were also persistent over time. We did not find any evidence that interventions were effective in influencing the exchange rate returns for the entire sample period.