Ann Finance https://doi.org/10.1007/s10436-018-0327-2 RESEARCH ARTICLE Vanishing central bank intervention in stochastic impulse control Gregory Gagnon Received: 10 July 2015 / Accepted: 25 May 2018 © Springer-Verlag GmbH Germany, part of Springer Nature 2018 Abstract Stochastic control of exchange rates when a central bank employs anti- inﬂationary stochastic differential equation (SDE) monetary policy is the key topic of our paper. Despite low money growth SDE policy means exchange rates invariably violate the central bank’s targets. Monetary policy also incorporates interventions reﬂected by sudden money supply jumps that moderate deviations from targets. Con- trolling exchange rates involves minimizing target deviation and intervention costs. Restrictions on these costs ensure intervention vanishes under the optimal control, implying the central bank engineers freely ﬂoating exchange rates instead of man- aged ﬂoating or ﬁxed exchange rates. Econometric evidence suggests discretionary interventions may be ineffective or generate excess volatility and speculation in cur- rency markets. Our result demonstrates mathematically that such collateral damage discourages intervention. Keywords Stochastic impulse control · Semimartingale · Value function JEL Classiﬁcation C61 · E58 · F31 · G12 1 Introduction Stochastic impulse control is a natural vehicle for modelling exchange rate stabilization via central bank intervention. At the heart of impulse
Annals of Finance – Springer Journals
Published: Jun 1, 2018
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