The Information Improving Channel of Exchange Rate Intervention: How Do Official Announcements Work?

This paper studies the relationship between official announcements and the effectiveness of foreign exchange interventions in a noisy rational expectations equilibrium model. We show that when heterogeneously informed traders have inaccurate information, an exchange rate is likely to be misaligned from its fundamental value in the presence of noise trades. Then the central bank uses the disclosure of public information to improve the accuracy of private agentsf information and encourage risk-arbitrage thereby enhancing the informativeness of the exchange rate. This effect holds, even when the central bank does not possess superior information to traders, as long as public information is not perfectly correlated with the information of traders. We provide evidence that announced interventions are more effective in periods of high implied volatility, consistent with the theoretical prediction that the implied volatility of the exchange rate is positively correlated with the information inaccuracy of traders and the degree of an exchange rate misalignment.