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Market microstructure effects of government intervention in the foreign exchange market

Author: Bossaerts, Peter ; Hillion, PierreINSEAD Area: Finance Series: Working Paper ; 89/67/FIN Publisher: Fontainebleau : INSEAD, 1989.Language: EnglishDescription: 30 p.Type of document: INSEAD Working Paper Online Access: Click here Abstract: An asymmetric information model of the bid-ask spread is developed for a foreign exchange market subject to occasional government intervention. Traditional tests of the unbiasedness of the forward rate as a predictor of the future spot rate are shown to be inconsistent when the rates are measured as the average of their respective bid and ask quotes. Three important results emerge from the empirical analysis. First, bid-ask spreads are larger on Fridays. Second, the volatility of the risk premium seems to depend onthe uncertainty about government intervention. Third, the forward bid-ask spread is asymmetric, namely the expected future spot rate is closer to the forward ask or the forward bid depending on wether a devaluation or a revaluation is expected
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An asymmetric information model of the bid-ask spread is developed for a foreign exchange market subject to occasional government intervention. Traditional tests of the unbiasedness of the forward rate as a predictor of the future spot rate are shown to be inconsistent when the rates are measured as the average of their respective bid and ask quotes. Three important results emerge from the empirical analysis. First, bid-ask spreads are larger on Fridays. Second, the volatility of the risk premium seems to depend onthe uncertainty about government intervention. Third, the forward bid-ask spread is asymmetric, namely the expected future spot rate is closer to the forward ask or the forward bid depending on wether a devaluation or a revaluation is expected

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