Central Bank Intervention and Overnight Uncovered Interest Rate Parity

This paper considers the impact of U.S. and German central bank intervention on the risk premium in forward foreign exchange markets. The model estimation is facilitated with the use of daily data on overnight Eurocurrency deposit rates, so that the interest rate maturity time of one day matches the sampling interval of the data. We also use the official net daily purchases and sales of dollars vis-à-vis the German Mark by the Federal Reserve System and the Bundesbank. The model involves FIGARCH innovations to model the degree of long term dependence in the volatility process. Some support is found for the intervention variables affecting the risk premium as predicted by theory. The impact of intervention in the two years immediately following the meltdown of the equity markets in October 1987 is particularly strong.