A Market Microstructure Analysis of Foreign Exchange Intervention in Canada
This paper clarifies the role and the impact of foreign exchange dealers in the relationship between foreign exchange intervention and nominal exchange rates using a unique dataset that disaggregates trades by dealer and by type of trade. The paper tests a number of market microstructure hypotheses. Results suggest that central bank orders and other customer orders are treated similarly by dealers who are engaged in short-run speculative and risk-sharing-motivated interdealer trading. While private payoff-relevant information is contained in trades, speculative interdealer trading is based only on transitory non-payoff-relevant information. A central bank considering intervention must consider both the signal it wishes to convey to the market and the subsequent trading strategies utilized by dealers.