Options and central bank currency market intervention: The case of Colombia

Abstract

Many central banks in emerging economies are concerned with excessive volatility in foreign exchange markets, especially those with inflation-targeting regimes. Historically, many have intervened using foreign exchange reserves in directly the spot market. However, these are not the only strategies available for intervention. The Colombian central bank implemented various intervention strategies while maintaining its inflation-targeting goals. In this paper we analyze the strategies employed by Colombia, with a special focus on the volatility option strategy. We argue that the abandonment of the currency options program for intervention was premature and that its success was not fully appreciated in previous literature.