A Test for the Presence of Central Bank Intervention in the Foreign Exchange Market with an Application to the Bank of Canada

Abstract

We propose a general non-linear simultaneous equations framework for the econometric analysis of models of intervention in foreign exchange markets by central banks in response to deviations of exchange rates from target levels. We consider the instrumental variables estimation of possibly non-linear response functions and tests of intervention when the functional form may be non-linear, asymmetric, and may contain unknown shape parameters. The methodology applies techniques developed for testing in the presence of nuisance parameters unidentified under a null hypothesis to a nonlinear simultaneous equations model. We report the results of an empirical analysis of activity of the Bank of Canada, for the period from 1953-2006, with regard to the Canada-U.S. exchange rate, with changes in foreign reserves proxying for intervention activity.