Foreign Exchange Interventions and their Impact on Expectations: Evidence from the USD/ILS Options Market

08/06/2022 |  Nathan Daniel, Hertrich Markus
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Foreign Currency
Using confidential daily data, we analyze how the intervention episode of the Bank of Israel (BOI) from 2013 to 2019 has affected the foreign value of the ILS and the expectations about its future value. We find that interventions amounting to USD 1 billion are on average associated with a depreciation of the USD/ILS and the Nominal Effective Exchange Rate (NEER) by 0.82%-0.85%, which is at the upper bound of the estimated impact in other studies. We stress that an intervention of USD 1 billion does not reflect the average daily intervention by the BOI and it serves as a benchmark to compare to other research papers in the field of FX interventions. The (indirect) effect on the forward rate is smaller - the BOI’s USD purchases have widened the negative deviation from covered interest parity. The higher moments of the risk-neutral probability distribution (RND) of future exchange rates extracted from USD/ILS options, on the contrary, are unaffected. The USD purchases simply shift the whole RND towards higher USD/ILS values. Crash risk, for instance, is unaffected. We also find that the USD/ILS options market anticipates intervention episodes and prices them in before they occur.