Abstract
We formulate a market microstructure model of exchange determination we employ to investigate the impact of foreign exchange (FX) intervention on exchange rates and on FX market conditions. With our formulation we show: (i) how FX intervention influences exchange rates via both a portfolio-balance and a signalling channel; and (ii) derive a series of testable implications which are coherent with a large body of empirical research. Our investigation also proposes some normative recommendations, as we show: (i) that in extreme circumstances large-scale FX intervention can have destabilizing effects for the functioning of FX markets; and (ii) that the route chosen for the implementation of official intervention has important implications for its impact on exchange rates and on market conditions. Copyright © 2010 John Wiley & Sons, Ltd.
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