## Foreign Exchange Intervention Rules for Central Banks: A Risk-based Framework

_IMF Working Papers, February 12, 2021_

## Source details

**Canonical URL:** [Foreign Exchange Intervention Rules for Central Banks: A Risk-based Framework](https://www.imf.org/en/publications/wp/issues/2021/02/12/foreign-exchange-intervention-rules-for-central-banks-a-risk-based-framework-50081)

## Other formats

- [Markdown version](/en/publications/wp/issues/2021/02/12/foreign-exchange-intervention-rules-for-central-banks-a-risk-based-framework-50081/index.md)
- [Structured JSON version](/en/publications/wp/issues/2021/02/12/foreign-exchange-intervention-rules-for-central-banks-a-risk-based-framework-50081/index.json)
- [Bundle manifest](/en/publications/wp/issues/2021/02/12/foreign-exchange-intervention-rules-for-central-banks-a-risk-based-framework-50081/bundle-manifest.json)

## Bibliographic details
- Authors: Romain Lafarguette, Romain M Veyrune
- Published: February 12, 2021
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513569406.001

---

### Overview
- Authors: Romain Lafarguette, Romain M Veyrune
- Publication date: February 12, 2021
- Purpose: Presents a rule for foreign exchange interventions (FXI) designed to preserve financial stability in floating exchange rate arrangements by addressing a market failure: the absence of hedging solution for tail exchange rate risk in the market (i.e. high volatility).
- Core mechanism: Uses the concept of Value at Risk (VaR) to define FXI triggers that provide the market a hedge against tail risk while allowing the exchange rate to smoothly adjust to new equilibria.
- Empirical scope: Backtested on Banco Mexico’s FXIs data between 2008 and 2016.

### Key findings and properties of the FXI rule
- Addresses market failure from lack of hedging solutions for tail exchange rate risk.
- Uses Value at Risk (VaR) to define intervention triggers.
- Provides to the market a hedge against tail risk while permitting smooth exchange rate adjustment to new equilibria.
- Budget neutrality: The rule is budget neutral over the medium term.
- Market incentives: Encourages prudent risk management in the market.
- Resilience: More resilient to speculative attacks than other rules, such as fixed-volatility rules.

### Methodology and empirical backtest
- Empirical methodology: Backtested on Banco Mexico’s FXIs data between 2008 and 2016.
- Key analytical concepts mentioned: Value at Risk (VaR), GARCH, Vector autoregression.
- Subjects and keywords used in the analysis: Currency markets, Exchange rate risk, Exchange rates, Foreign exchange, Vector autoregression; central bank intervention frequency, Foreign Exchange Interventions, FXI risk mitigation, GARCH, intervention region, market participant, Value at Risk, var FX intervention rule, WP.

### Policy implications and recommendations
- Implement an FXI rule based on VaR to mitigate tail exchange rate risk when market hedging solutions are absent.
- Design interventions to be budget neutral over the medium term to avoid fiscal stress from FXI operations.
- Favor rules that preserve exchange rate flexibility and allow smooth adjustment to new equilibria rather than fixed-volatility rules that may be more vulnerable to speculative attacks.
- Encourage market mechanisms and regulation that promote prudent risk management among market participants.

---

## Content in this bundle

- **Working Paper**
  - [Working Paper (Markdown version)](/-/media/files/publications/wp/2021/english/wpiea2021032-print-pdf.pdf.md){rel="alternate" type="text/markdown"}
  - [Working Paper (PDF)](/-/media/files/publications/wp/2021/english/wpiea2021032-print-pdf.pdf){rel="external" type="application/pdf"}

---

_Source: https://www.imf.org/en/publications/wp/issues/2021/02/12/foreign-exchange-intervention-rules-for-central-banks-a-risk-based-framework-50081_