We study the impact of Central Bank intervention on the process of price formation in currency markets. We use a unique dataset of tick-by-tick indicative quotes posted by dealers on Reuters terminals and of intraday sterilized spot interventions and customer transactions executed on behalf of the Swiss National Bank (SNB) on the Swiss Franc/U.S. Dollar exchange rate (CHFUSD) between 1986 and 1998. We find that potentially informative SNB interventions (but not ex post uninformative customer transactions), although small relative to daily trading volumes in the CHFUSD market, had significant and persistent (albeit asymmetric, depending on their sign) effects on daily currency returns, especially when (relatively) large in magnitude, expected by the market, or inconsistent with existing momentum. The market did not anticipate the occurrence of incoming interventions un-less if chasing the trend. The SNB was much less successful in smoothing fluctuations of the currency, for daily CHFUSD volatility always surged in proximity of interventions, as did average absolute and proportional spreads. Decomposition of estimated absolute spread shocks also reveals that SNB actions induced misinformation among market participants, impacted trading immediacy, and increased market liquidity and competition among dealers. Many of these changes translated into higher transaction costs borne by the population of investors.

We study the impact of Central Bank intervention on the process of priceformation in currency markets. We use a unique dataset of tick-by-tick indicativequotes posted by dealers on Reuters terminals and of intraday sterilized spot interventions and customer transactions executed on behalf of the Swiss National Bank (SNB) on the Swiss Franc/U.S. Dollar exchange rate (CHFUSD) between 1986 and 1998. We find that potentially informative SNB interventions (but not ex post uninformative customer transactions), although small relative to daily trading volumes in the CHFUSD market,had significant and persistent (albeit asymmetric, depending on their sign)effects on daily currency returns, especially when (relatively) large in magnitude,expected by the market, or inconsistent with existing momentum. The market did not anticipate the occurrence of incoming interventions unless if chasing the trend. The SNB was much less successful in smoothingfluctuations of the currency, for daily CHFUSD volatility always surged inproximity of interventions, as did average absolute and proportional spreads.Decomposition of estimated absolute spread shocks also reveals that SNB actionsinduced misinformation among market participants, impacted trading immediacy, and increased market liquidity and competition among dealers. Many of these changes translated into higher transaction costs borne by the population of investors.

The relationship of stock returns and trading volume is the focus of much recent interest. I examine an economic model of a rational trader who operates in a market with transactions costs and noise trading. The level of trading affects the rational trader’s marginal cost of transacting; as a result, trading volume is a source of risk. This engenders an equilibrium relationship between returns and volume. The model also provides a simple way to scrutinize this relationship empirically. Empirical evidence supports the implications of the model.

This paper examines dollar interventions by the G3 governments since 1989, and the reasons that trader reactions to these interventions might differ over time and across central banks. Market microstructure theory provides a framework for understanding the process by which sterilized central bank interventions are observed and interpreted by traders, and how this process, in turn, might influence exchange rates. Using intra-daily and daily exchange rate and intervention data, the paper analyzes the influence of interventions on exchange rate volatility, finding evidence of both within day and daily impact effects, but little evidence that interventions increase longer-term volatility.