Central bank intervention, threshold effects and asymmetric volatility: Evidence from the Japanese yen-US dollar foreign exchange market

Recent empirical evidence of nonlinearities in the time series behaviour of exchange rates suggests that a linear model of the exchange rate may yield invalid inference when used to assess the effectiveness of central bank intervention. Using a double threshold GARCH model of the Japanese yen-US dollar exchange rates, we find that interventions by the Bank of Japan and the Federal Reserve are more effective in changing the direction of the exchange rate movements and reducing its volatility level in a regime when the exchange rates are severely misaligned. There is also evidence in such a regime for a negative return innovation to elicit higher levels of volatility than a positive innovation of equal magnitude. The presence of asymmetric volatility in exchange rate returns may be a result of active central bank intervention.