Vanishing central bank intervention in stochastic impulse control

Vanishing central bank intervention in stochastic impulse control 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 http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Annals of Finance Springer Journals

Vanishing central bank intervention in stochastic impulse control

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Publisher
Springer Journals
Copyright
Copyright © 2018 by Springer-Verlag GmbH Germany, part of Springer Nature
Subject
Finance; Finance, general; Economic Theory/Quantitative Economics/Mathematical Methods; Quantitative Finance; Macroeconomics/Monetary Economics//Financial Economics
ISSN
1614-2446
eISSN
1614-2454
D.O.I.
10.1007/s10436-018-0327-2
Publisher site
See Article on Publisher Site

Abstract

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

Journal

Annals of FinanceSpringer Journals

Published: Jun 1, 2018

References

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