Modelling Foreign Exchange Interventions under Rayleigh Process: Applications to Swiss Franc Exchange Rate Dynamics

This paper models the foreign exchange intervention policy following the Rayleigh process derived from the standard flexible-price monetary framework. The exchange rate dynamics associated with the interventions are more sensitive to the change in the economic fundamental when a currency's money supply is ample and its appreciation expectation cannot be offset by lower interest rates that have fallen to the zero lower bound, suggesting that more intensive interventions are required to counteract currency appreciation pressure and resulting in foreign reserve accumulation. The empirical results using market data during January 2015-February 2020 demonstrate that the model can describe the dynamics of the Swiss franc exchange rate. The accumulation of foreign reserves through interventions is negatively co-integrated with the exchange rate volatility and the value of the mean level of the Swiss franc exchange rate in the dynamics, to some extent indicating a reasonably high degree of effectiveness of the Swiss National Bank's interventions. The transition between the target-zone and floating-rate regimes in 2015 caused changes in the level of exchange rate volatility but not its dynamical structure, suggesting that transitions between the floating-rate and target-zone regimes do not seem to have material consequence in this regard.