BIS Working PapersNo 429 On central bank interventions in the Mexican peso/dollar foreign exchange market by Santiago Garca-Verd and Miguel Zerecero Monetary and Economic Department September 2013 Paper produced as part of theBIS Consultative Council for the Americas Research Network project on the Effects of Foreign Exchange Market Operations inLatin America JEL classification: E5, F31. Keywords:foreignexchangerate,centralbank interventions, microstructure. BISWorkingPapersarewrittenbymembersoftheMonetaryandEconomic DepartmentoftheBankforInternationalSettlements,andfromtimetotimeby othereconomists,andarepublishedbytheBank.Thepapersareonsubjectsof topicalinterestandaretechnicalincharacter.Theviewsexpressedinthemare those of their authors and not necessarily the views of the BIS. This publication is available on the BIS website (www.bis.org). Bank for International Settlements 2013. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISSN 1020-0959 (print) ISBN 1682-7678 (online) 1 On central bank interventions in the Mexican peso/dollarforeign exchange market1,2 Santiago Garca-Verd3 Bank of Mexico Miguel Zerecero4 Bank of Mexico First draft: April 2012 Final draft: September 2013 Abstract InrecentyearstheBankofMexicohasmadeaseriesofrules-based interventionsinthepeso/dollarforeignexchangemarket.Weassessthe effectivenessoftwospecificinterventionsthatoccurredinperiodsofgreat stressfortheMexicaneconomy.Theaimsofthesetwointerventionswere, respectively,toprovideliquidityandtopromoteorderlyconditionsinthe foreignexchangemarket.Forouranalysis,wefollowtheframework implementedbyDominguez(2003)andDominguez(2006),anevent-style microstructureapproach.Weusethebid-askspreadsasameasureofliquidity and of orderly conditions. In general, our results show no indication of an effect intheoppositedirectionfromtheoneintendedforthefirstinterventionand arefairlyconclusiveregardingasignificantreductiononthebid-askspreadfor the second intervention. Keywords: foreign exchange rate, central bank interventions, microstructure. JEL codes: E5, F31.

1 The views expressed in this paper are those of the authors and do not necessarily reflectthose of the Bank of Mexico or the BIS. 2 This is the Individual Country Paper for the BIS CCA Research Working Group on Foreign Exchange Market Operations.WearegratefultoManuelRamos-Francia,AlbertoTorres,andAnaMaraAguilarfortheir continuoussupport.WewouldalsoliketothankRodrigoCano,RasmusFatum,JuanManuelJulioRomn, Carlos Montoro, Roberto Gmez, Daniel Smano,Julio Santaella, Hernn Rincn Castro, Marco Vega, Paolo Vitale,andtheparticipantsoftheCCABISConferencesinMexicoCity,Cartagena,andSantiago.Special thankstoAlainChaboud,KathrynDominguez,andRamnMoreno,fortheirdetailedcommentsand support. We thank the Directorate of Operations Support for providing us with exchange rate data. Finally, we would like to acknowledge Andrea Pramo as a co-author in the initial stages of this paper.3 Adviser to the Board, contacting author: sgarciav@banxico.org.mx 4 Economist, Directorate of Economic Studies, General Directorate of Economic Research.2 Introduction Thispaperhasatwofoldobjective.First,weseektooutlinethepeso/dollarmarkets organisation,aswellasthebehaviouroftheintradaypeso/dollarexchangerateand,in particular,thedynamicsofitsbid-askspread.Second,weassesstwospecifictypesof intervention that were intended, respectively, to provide liquidity and to promote orderly conditionsintheforeignexchangemarket.Tomeasureliquidityandthedegreeof orderlinessintheforeignexchangemarket,weusetheexchangeratebid-askspread. Wherethebid-askspreaddiminishes,weinterpretthisasanincreaseinliquidityand/or moreorderlyconditions,otherthingsbeingequal,andviceversa.Thereare,ofcourse, severalchallengeswhenitcomestomeasuringaninterventionseffectiveness.Of particular concern are the construction of the control sample and the selection of a set of control variables.Tothisend,wefollowtheapproachproposedbyDominguez(2003)andDominguez (2006). Specifically, we use a study-event microstructure approach to interventions. In the samewayasDominguez,weuseintradaydataandcontrolforaselectedsetof macroeconomic variables with a view to accounting for differences in the macroeconomic scenario when comparing the dynamics of the exchange rateboth during an intervention and at other times.Inrecentyears,Mexicohasimplementedseveraltypesofinterventions.Insteadof attemptingtoassesseveryintervention,wefocusforthefollowingreasonsontwo specifictypes.First,thesetwointerventionstookplaceinthesametimeperiodandhad similaraimsandcharacteristics.Thisallowsustousebid-askspreadstomeasurethe effectivenessofbothinterventions.Thefirsttypeofinterventionwasbyfarthemost importantoneintermsofdollarstendered.5Weleavetheanalysisofothertypesof intervention to be undertaken in future research. It has been established in the literature that some short-run aspects of the exchange rates cannotbe explained byconventionalasset pricingmodels(Sarno andTaylor(2002)).Itis the microstructure approach that often sheds light on our understanding of the short-run behaviouroftheexchangeratesand,inparticular,ontheeffectivenessofcentralbank interventions in the foreign exchange market. Theeffectivenessofinterventionhasbeenamatterofmuchdebateintheliterature (SarnoandTaylor(2002)).Infact,DominguezandFrankel(1993)challengedthe conventionalwisdomofthetime,whichwasthatinterventionswereessentially

5 Note that we refer to the amount tendered, not to the amount allocated.3 ineffective.Butimproveddataavailabilityduringthepastseveralyearshasshapedthe perception of their effectiveness.Ourmainresultscanbesummarisedasfollows.Forthefirstintervention,thereisno indicationofaneffectintheoppositedirectionfromtheoneintendedand,forthe second, there is fairly conclusive evidence for a significant reduction in the bid-ask spread. Theseresultsholdeventhoughwehaveconsideredseveralspecifications.Weexplore some of the reasons why this might be the case. Further research is thus warranted.Therestofthepaperisdividedintosevensections.Inthefirst,wepresentabrief literaturereview.Theseconddescribestheorganisationofthepesoforeignexchange market,highlightingcertaincharacteristicsthatmighthaveimplicationsforourresults. The third section outlines the different types of intervention implemented by the Bank of Mexicointherecentyears,particularlytheonesweanalyseinthispaper.Thefourth sectionexaminesseveralkeyaspectsofthedata,includingsomestatistics.Thefifth considers the use of the bid-ask spread to measure liquidity and orderly conditions in the foreignexchangemarket.Thesixthassessestheeffectivenessofaspecifictypeof intervention, using the bid-ask spread as a yardstick. The last section concludes. Literature review We divide our literature review into two parts. In the first part, we recap several topics in the interventions literature. Our survey is based on Lyons (2001), Sarno and Taylor (2002), andVitale(2005).Weincludethisoverviewtomakeourpaperasself-containedas possible. In the second part, we summarise what we believe is the most relevant research on interventions on the Mexican peso/dollar exchange rate.A key issue is the rationale for interventions. A strand of literature explores this issue. For example,onethemeistheso-calledwrongrateargument.Onthisview,theauthority believesthattheexchangeratedoesnotreflecttheprevailingfundamentalsofthe economy.Thisrationalehingesupontheassumptionthattheauthorityhasan informationaladvantagewithrespecttomarketparticipants.Ineffect,onecanpresume thatacentralbankknowsmoreaboutfuturemonetarypolicythanmarketparticipants. Nonetheless, there are some drawbacks. For example, authorities may not be in a position todeterminetheequilibriumexchangeratebasedoneconomicfundamentals.Ifthatis the case, an intervention might have unintended side effects.Second, an interventions effects depend crucially on whether or not it is sterilised. When itisunsterilised,theeffectsofaninterventionaresimilartothoseofanopenmarket operation, as the monetary baseis changed. The key difference is that, in an unsterilised 4 intervention,thebankusesmainlyforeignassets,whileinanopenmarketoperationit uses domestic assets.Inthecaseofasterilisedintervention,bycontrast,theliteraturehasfocusedmainlyon twopossiblechannelsthroughwhichitmighttakeeffect,namely,theportfoliobalance and the expectations or signalling channel. We look at each in turn.Intheportfoliobalancechannelasaninterventiontakesplace,financialinstitutions(eg) buydollarsdirectlyfromthecentralbank.Inthesterilisationprocess,thecentralbank buysdomesticbondsfromthepublic.Thus,therelativesupplyofdomestictoforeign bondsdecreases.Ifdomesticandforeignbondsareimperfectsubstitutes,insuchcase, then their relative prices would change, lifting the exchange rate.IntheMexican-UScase,itisreasonabletoassumethatdomesticandforeignbondsare imperfectsubstitutes.6Frankel(1982)andObstfeld(1983)findthat,intheDeutsche mark/dollarforeignexchangemarket,theportfoliobalanceeffectsaresmall.Fortheir part,DominguezandFrankel(1993)makethecasefortheimportanceofthischannel usingthedeviationsfromtheUIPasameasurementofriskpremiumintheforeign exchange market. AnunderlyingassumptionintheportfoliochannelargumentiswhetherRicardian equivalenceholds.Toseethis,supposethattheforeignanddomesticbondsareperfect substitutes. Now, say, that financial institutions buy dollars from the central bank and that the sterilisation process involves the central bank buying domestic bonds from the public, leadingtoareductionintherelativesupplyofdomesticbonds.Ifthesebondswere perfect substitutes, the argument goes, their relative prices wouldstay put. Nonetheless, supposethattheyareperfectsubstitutesbutalsothatRicardianequivalenceholds. Accordingly, as agents know that the domestic government will eventually need to obtain additionalrevenuesfromothersources,theywouldthenincreasetheirsavings,which would partially offset the intervention effect. In sum, the perfect substitutability of bonds is not a sufficient condition for the portfolio channel effect to be present.Second,theexpectationsorsignallingchannelwillhaveaneffectifparticipantsperceive theinterventionassignallingthecentralbanksintentionswithregardstoitsfuture monetary stance (Mussa (1981)). In this case, it is irrelevant whether domestic and foreign bondsaresubstitutesornot.Dominguez(1987)studiesthecentralauthorityscapability to signal its monetary policy intentions.

6 One might argue that the substitutability has increased in recent years.5 In ourcase, an effect through the expectations channel is most probably weak insofar as theinterventionsconsideredarerules-based.Nonetheless,theactualpolicyvariableof theperiodinwhichtheinterventionisactiveorsomevariationsastotheir implementation might play some role in this respect, presumably at a low frequency. It is worth pointing out that the central banks aims of providing liquidity or promoting orderly conditionsdonotprecludethesechannelsfromplayingapart.Yet,wedonotintendto quantify their effects.Third,arelatedissueiswhetheraninterventionshouldbepublic,rules-based,and transparent,orwhetheritshouldbediscretionaryandprivate.Ontheonehand,to rephraseKenen(1988),therulesoftheforeignexchangemarketneedtobeas transparentaspossibletomaintaincredibility.Thus,theauthoritieshaveanincentive to clearlyconveytheirintentionsfortheexpectationschannel to bemore effective.Onthe other hand, Dominguez and Frankel (1993) have considered whether the authorities might haveanincentivetokeeptheeffectsofaninterventiontoaminimumundersome circumstancesand,insuchcases,tomakeitprivateanddiscretionary.Cuckiermanand Meltzer(1986)arguethatapublicinterventionunderanadversemacroeconomic environment,forexampleiftheauthoritylacksahighdegreeofcredibility,mightbe unfavourable.Anothercasemightbewhenacentralbankwishesonlytoreadjustits reserves portfolio and, thus, chooses a stealth intervention.Fourth,thereisthequestionofwhethercoordinatedinterventionsbyauthoritiesintwo countries are more effective than an intervention implemented by just one country on its own.Themainrationaleforsuchanapproachisthepotentialforpolicyspillovers.Thus, forinstance,iftwointerventionsareintendedtohaveoppositeeffects,itisinthe authorities interests at least to share some information. In this matter, Kenen (1995) has foundthatcoordinatedinterventionshavetendedtobemoreeffectivethanunilateral ones.Inthecaseofanunsterilizedcoordinatedintervention,theeffect ontheexchange rate would be affected by the relative monetary policy stance.Coordinatedinterventionsbetweensovereignentitiescanbestudiedunderthe framework of non-cooperative repetitive games. They entail governmental strategies. For example,BuiterandEaton(1986)studyoptimalmonetarypoliciesininterdependent economies.Ingeneral,theliteraturerecognisesthatimportantgainscanensuefrom cooperation,althoughanequallyimportantissueistounderstandwhengovernments havetheincentivetocooperateand,thus,whentheyaremorelikelytoreacha cooperative equilibrium.6 Sixth,akeypointiswhether themodelat hand assumesrationalexpectations.Insucha case,asiswellknown,thereisajointhypothesisproblem.Inassumingrational expectationsandrejectingamodel,oneneverknowswhethertherejectionisduetoa violation of rational expectations or to the model. In this respect, Dominguez and Frankel (1993)haveasarelativeadvantagethattheydonotassumerationalexpectations,and arecapableofjointlymeasuringtheeffectsofbothchannels.Theyfindstrongevidence that a sterilised intervention affects the exchange rate through both channels. In addition, theyfindthat theeffectisaugmentediftheinterventionispubliclyannounced,whichis consistent with Kenen (1988). Seventh,animportantthreadoftheliteratureisthestudyofthecentralbanksreaction function.Itischallengingbothtopositandestimateareactionfunctionbecausecentral banks take into consideration several elements when making a decision to intervene. We conjecture that formulating a reaction function is less of challenge when the interventions being considered are rules-based.Moving on to the research on the Mexican peso exchange rate literature, we would like to highlightthefollowingpapers.Inaddition,itisworthmentioningthatthispartofthe literature is at a relative incipient stage.First, Sidaoui (2005) provides an excellent overview of the Bank of Mexicos interventions between1995and2004.Thestartofthisperiodwasmarkedbythreekeyevents:the Mexican crisis, the depletion of Mexicos international reserves, and the pesos flotation.Second,Archer(1995)providesadescriptionoftheinterventionmethodsusedin different countries. He analyses how the methods implemented by the authorities depend ontheaimsandthemacroeconomicenvironment.Also,hehighlightsthedesignof interventions in the Mexican case, particularly the preannounced quantities and rules that triggered the intervention with a view to ensuring transparency.Third,Isshietal(2006)presentanextensivestudyofforeignexchangeinterventions, usingMexicoandTurkeyascasestudies.Interestinglyenough,theseauthorspointto someofthepossiblereasonswhyinterventionsindevelopingeconomiesmightbemore effectivethanthoseinadvancedeconomies.Inparticular,theyarguethatmany [emergingmarket]countriesinterveneinamountsthatarelargerelativetomarket turnover. They also use a variety of foreign exchange, monetary, and banking regulations that effectively constrict the size of the market, increasing the central banks size in it. Fourth,Broto(2012)comparestheeffectsofinterventioninfourLatinAmerican countries,namely,Chile,Colombia,Mexico,andPeru.Shefindsthattheeffectis differentiated according to whether foreign currency is bought or sold. She also finds that, 7 in general, volatility is reduced by the interventions and that the interventions size plays a minor role. Fifth,DomaandMendoza(2004)arguethatinMexicocentralbankforeignexchange sales were generally effective in influencing the exchange rate. Moreover, Guimares and Karacadag (2004) find only weak supportive evidence for aneffect of one intervention on theleveloftheexchangerateinMexico.Furthermore,GuimaresandKaracadag(2004) do not find that the interventions had a significant impact on exchange rate volatility. Description of the peso/dollar foreign exchange marketTheMexicanpesoistheworlds13thmosttransactedcurrencyaccordingtotheBIS TriennialCentralBankSurveyofForeignExchangeandDerivatives(2010).7Asshownin Figure1,whichpresentstheaveragedailyturnovervolumesintheglobalforeign exchangemarketforagroupofselectedcurrencies,turnoverintheMexicanpesohas exceeded those of the Brazilian real, the Russian rouble, the Indian rupee, and the Chinese renminbiinrecentyears.Andthesevolumesincreasedsignificantlyduringtheyears considered in this study. Figure 1 Turnover in the global FX market for selected currencies1,2 (% daily average transaction volume) 1. As all transactions involve two currencies, the totals add up to 200%.2. Each datum is with respect to April of each year.Source: BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives (2010).

7 Other related surveys are those made by the FederalReserve Bank of New York and the Bank of England. Their results are for the most part consistent with the data presented in this section. 0.00.20.40.60.81.01.21.41.61998 2001 2004 2007 2010Brazil ChinaChile ColombiaKorea IndiaMexico PolandRussia Czech Rep.8 Thepesoforeignexchangemarkethasseveralsignificantcharacteristics.First,Table1 presentstheaveragedailyturnoverinthespot,forwardsandswapsmarkets.Asshown, theswapsmarketaccountsforthebulkofthesetransactions.Second,sinceMay2008, thepesoswindowofoperationhasbeenextendedto24hours.Inthatmonth,the MexicanpesojoinedtheContinuousLinkedSettlement(CLS),thelargestmulti-currency cashsettlementsystemintheworld.Besidesextendingitshoursofoperations,this developmenthashelpedtoreducethepesossettlementrisk.Thus,thecurrencysCLS accession has undoubtedly been very significant, as we explain in more detail below.Table 1 Average daily turnover (in millions of US dollars) SpotForwardsSwaps Banks and stock exchange 4,77064414,683 Source: Bank of Mexico. All in all, the Mexican peso market has made significant progress in recent years in terms ofitsdepth,liquidity,andsettlementrisk.Infact,turnoverinthespotandassociated marketsisnowcomparabletothatofcurrenciesbelongingtofinanciallydeveloped countries. Interventions in the peso/dollar foreign exchange market The central banks interventions in the peso/dollar foreign exchange market are a relevant topicformanyreasons.Tobeginwith,theexchangerateisanimportantchannelof monetarypolicy,sothatanyvariationinmonetarypolicystancemightaffect,albeit indirectly,theexchangerate.Second,thepesoforeignexchangemarkethasgrown vigorously,togetherwithitsoptionsandfuturesoffshoots.Third,theexchangerateis probably one of the Mexican economys most important prices, given the condition of an openeconomyintermsofbothcapitalflowsandtrade.Alsoofrelevanceisthesheer volumeofremittancessenttoMexicofromtheUnitedStates.Thus,understandingtheir effects should be of fundamental interest to policymakers. IntheMexicancase,theentityresponsiblefordecidingoninterventionsandonmatters relatingtothestructureoftheforeignexchangemarketistheForeignExchange Commission(ComisindeCambios).ThisbodycomprisestheSecretaryandaDeputy Secretary of the Secretariat of Treasury and Public Credit (Secretara de Hacienda y Crdito Pblico(SHCP),asecondDeputySecretaryoftheSHCP,theGovernoroftheBankof Mexico,andtwomembersofitsBoardofGovernors.TheSecretaryofSHCPhasthe 9 castingvoteandoperationallythecentralbankisresponsibleforimplementingthe interventions. Inrecentyears,theBankofMexicohasusuallyintervenedaccordingtoarules-based approach.Typically,theaimshavebeentoprovideliquidity,topromoteorderlymarket conditions, toreducevolatilityin theforeignexchangemarketandtochangetherateof reserves accumulation.Whilewewillfocusontwospecificinterventions,inwhatfollowsweprovideabrief overview of all interventions undertaken in recent years. The main characteristics of other interventions are of significance for this study as they took place during one of the periods we have used for our control sample.1.Auction sales of dollars to reduce the rate of reserves accumulation. This mechanism is intendedtoreducetherateofaccumulationofinternationalreserves,asitsname suggests. The implementation was announced on 7 March 2003. The intervention was then active from 2 May 2003 to 1 August 2008. The total amount tendered was USD 30,082 million. The interventions timestamp was 09:30., lasting for two minutes. This type of intervention was on four occasions followed by a second auction on the same day: on 26 June 2003; 12 November 2004; 23 March 2005; and 22 April 2005. 2.Extraordinaryauctionsalesofdollars.Thisinterventionwasintendedtoprovidethe liquidity needed to improve the conditions in an environment of uncertainty and lack of liquidity in the foreign exchange market.It was implemented on five days only: 8, 9, 10, 16 and 23 October 2008. The total amount tendered was USD 12,502 million. 3.Auction of dollars with a minimum price. This is one of the two interventions that we focus on in this paper.As in the case of the Type 2 intervention, the aim was to provide the funds needed to combatuncertaintyandlackofliquidityintheforeignexchangemarket.This interventionwasinitiallyactivefrom9October2008to9April2010.Thetotal amounttenderedbetween2008and2011wasUSD351,058million.Theauctions tookplacethreetimesaday:at09:30,11:30and13:00,lastingforfiveminuteson eachoccasion.Werefertothisperiodasthefirstepisode.Theinterventionwas repeated as of 30 November 2011. Starting on that date, the intervention times were changed to 09:00, 12:00 and 15:00. We refer to this period as the second episode. In this paper we focus on the first episode, for the reasons explained below.Itisworthmentioningthatseveralchangesweremadetothemaximumallocated daily amount. On 8 October 2008, the commission announced that, as of the next day, this type of auction would take place with a maximum allocated daily amount of USD 400million.On5March2009thecommissionannouncedthat,asof9March,the 10 maximumallocateddailyamountwouldbeUSD300million.On29May2009,the commission announced that as of 9 June the maximum allocated daily amount would be USD 250 million. Inwhatfollows,weexplainsomeoftheauctionslogisticsinmoredetail.The auctionsminimumpricewassetatthepreviousworkingdaysexchangerateplus 2%.Moreprecisely,min_pricet=pt-1x1.02wherept-1isequaltotheFIXexchange rateofdayt1ifnoauctiontookplacethedaybefore,ortheaveragepriceofthe auctions of day t1, if an auction took place.8 The minimum price is the same for each auction on the same day.Auctions are convened some minutes before they actually take place. The participants placeeachbidasafunctionofaprice(pi)andaquantity(qi).Thetimethatabidis placed is also relevant (ti) in case of draws. Thus, in order for any participant to obtain anallocation,anecessaryconditionistohavehisbidbepimin_pricet..As mentioned, auctions last five minutes.DenotethemaximumpossibleallocateddailyamountbyM.Themaximumpossible allocated amount ineach auction depends on M and the amount actually sold in the previous auction on the same day.Thus,M9,M11,M13denote,respectively,themaximumpossibleallocatedamountin the09:30,11:30and13:00auctions.Inaddition,ndenotesthenumberof participants in the auctions. To fix ideas, suppose that p1 p2 p3 pn.Forthe9:30auction,M9alwaysequalsM.Oncebidsarein,ifpiqiM9thenthe centralbankstartsallocatingthedollarstothehighestbidder,thentothenext highest bidder, and so forth, until all bids are satisfied. Being a multiple price auction, each participant obtains the price he bid at. If npiqi>M9,then the participantsarenotified oftheminimumpriceatwhichthey must rebid if they are to have a chance of getting some dollars assigned, the so-called marginal price. If the new round of bids is such that npiqi M9, then the dollars are assigned and the auction is over. If, however, the bids are such thatnpiqi > M9 before the time is up, the participants are notified of the new marginal price, and thus are able to resubmit a bid.

8 The FIX exchange rate is an average of wholesale market quotes obtained from electronic trade platforms and other electronic sources that are representative of the foreign exchange market. These quotes are collected three times a day, between 09:00 and 12:00, and the resulting average is the exchange rate known as the FIX. 11 If npiqi > M9 by the time is up, the auction is over and the dollarsare allocated until mpiqi M9, where m n. It might be the case that the mth participant might not get his full amount assigned, qm. If that is the case, participants m+1th, m+2th, , n get no allocation.For the 11:30 auction, let M11 equal to max{M9 - npiqi,0}, where the {(pi,qi)}n are the prices and quantitiesassigned in the 09:30 auction. If M11 = 0 then there is no11:30 auction.Otherwisetheauctionisimplementedasthe09:30auction,exceptforthe fact that M11 is the new maximum amount.For the 13:00 auction, likewise, let M13 equal to max{M11 - npiqi,0}, where {(pi,qi)}n are the prices and quantities associated with the 11:30 auction. If M13 is 0 then there is no 13:00 auction. Again, the auction is otherwise implemented as the 11:30 auction except that M13 is the new maximum amount to be auctioned.If, in any auction, there is a draw in terms of the bid price, the participant that sent its bid first has preference over the other. At the end of each auction, the bids are made knowntotheparticipants,buttheinstitutionsnamesassociatedwiththemarenot revealed. 4.Auctionofdollarswithoutminimumprice.Thisisthesecondinterventionthatwe studyhere.Itisintendedtopromoteorderlyconditionsintheforeignexchange marketandwasestablishedasamechanismforsellingasignificantportionofthe projectedaccumulationofinternationalreservesintheexchangemarket.The auctionstookplacefrom9March2009to30September2009withatotaltender amount of USD 10,250 million. The timestamp for this intervention was 09:10, lasting forfiveminutes.Thiswasfollowedonthreeoccasionsbyasecondinterventionon thesameday:25March2009;1April2009;and3April2009at10:00,lastingfive minutes each. ThenatureoftheauctionfortheType4interventiondiffersfromtheType3 intervention by having no minimum price and no triggering rule. In effect, the auction is convened every working day. There is a daily maximum amount. Theauctionsareinteractive,ieparticipantsknowthebidsduringtheauctionand couldimprovetheirbid.Morespecifically,participantspresenttheirbidswitha continuous knowledge of the marginal price. This new intervention policy remained current until 8 June 2009. On 29 May 2009, the Exchange Rate Commission announced modified terms and conditions for the ensuing months, reducing the maximum amount of auctionsales from USD 100 million to 50 million per day starting from 9 June until 8 September 2009. On 1 September, it was announced that the auctions would be continued until 30 September and suspended on 1 October 2009. 12 5.Dollarcreditauction.Theresourcesforthisauctioncamefromtheswapline negotiatedwiththeFederalReserve.Thesewereusedtoconductauctionsofdollar creditsamongbankswiththeconditionthattheydistributethosedollarstothe domesticallybasedcorporationsthatneededthem.9Thefirstandonlyauctiontook place on Tuesday 21 April 2009, in which USD 4,000 million was tendered. The auction started at 12:30, lasting for 30 minutes. 6.Auctionsalesofdollars(put)options.Thismechanismwasintendedtosupportthe accumulationofinternationalreserves.Theauctionstookplaceat12:30,lasting30 minutesoneachfinalworkingdayofthemonthbetween26February2010and31 October 2011. In this auction, the central bank sold put options on dollars. The holder had,foramonth,theoptionbutnottheobligationofsellingagivenamountof dollarstothecentralbankprovidedthattheprevailingexchangeratewasbelowa moving average of the exchange rate.Inourcase,thisinterventionwasimplementedonthedatessurroundingoneofour non-intervention samples. In this regard, although the options can be exercised at any timeduringtheone-monthhorizon,theyarespecificallydesignednottoaffectthe foreignexchangemarketintheperiod,astheoptionholdersareabletoexercise them only when there is a relative excess of dollars in the market. 7.Directsales(discretionary).Thistypeofinterventionwasintendedtoattenuatethe volatility of the foreign exchange market. Theassociated interventions took place on 4,5,6,20,23and27February2009.TheForeignExchangeCommissionestablished the tendered amounts and exact timing. All these interventions were sterilised. Essentially, as part of the daily operations ofBank ofMexico,themoneymarketsliquidityrequirementsareestimateddailysubjecttothe exigenciesofthemonetarypolicystance.Thus,theresultsofeachinterventionauction are notified to the office that plans the daily liquidity requirements in the money market. Thisofficethentakesintoaccounttheauctionsresults,ineffect,sterilisingthe intervention.Aspreviouslydiscussed,theeffectofaninterventiondependscruciallyon whether it is sterilised. Inthiscontext,togiveasenseoftherelativeimportanceofthedifferenttypesof interventions,Figures2and3depict,respectively,thenumberofinterventionsandthe tendered amounts of each type. Note that these data refer to the tendered amounts, not

9 According to the Bank of Mexicos press release of 29 October 2008, the swap lines were set between the Bank of Mexico, the FederalReserve,theCentralBank ofBrazil, Bank ofKorea, and Monetary Authority of Singapore.Thesewereintendedtohelpimproveliquidityconditionsinglobalfinancialmarketsandto combat difficulties in obtaining US dollar financing in well managed economies with strong fundamentals. 13 theactualallocatedamount.Bythenumberofinterventions,Type1andType3are clearlyaheadofthepack.Yet,bythetotalamounttendered,theType3intervention comesoutontop,whichspeakstoitsrelativeimportance.InformationontheType7 intervention is not included since it is not publicly available. Figure 2 Number of interventions This figure depicts the number of interventions of each type, regardless of the amount offered. Type 1 and Type 3 account for the bulk of these interventions. 1,269 5 1,188 146 1 21 6 Intervention Type 1 Intervention Type 2 Intervention Type 3Intervention Type 4 Intervention Type 5 Intervention Type 614 Figure 3 Total amount tendered in each intervention type (Millions of US dollars) Totalamountofferedineachinterventiontype,inmillionsofUSdollars. Type3interventionsaccountformorethanthreequartersofthetotal amount tendered. Figure4givesabroadpictureofthetimeperiodsinwhichtheinterventionswere implemented. Note that this is a snapshot of the actual intervention days, as auctions only take place on specific days. Also recall that the Type 6 intervention is implemented only on the last day of each month. More concretely, the Type 3 intervention overlaps with Type 2 interventions (on 9, 10, 16 and 23 October 2008), Type 4 (during its entire duration), Type 5 (4 April 2009), Type 6 (on 26February2010and31March2010)andType7(on4,5,6,20,23and27February 2009). The total number of days that interventions other than Type 3 were active was 152, (143 for Type 4, 1 for Type 5, 2 for Type 6, and 6 for Type 7). The different timestamps of theseinterventionsare:Type4at09:10,andType5and6at12:30.ForType7,the timestampwasestablishedbytheForeignExchangeCommissionbecausethiswasa discretionaryintervention.Insum,theseeventsaredeemedtocompriseourcontrol sample.30,082 12,502 351,058 10,250 4,000 12,600 Intervention Type 1 Intervention Type 2Intervention Type 3 Intervention Type 415 Figure 4 Intervention calendar

Source: Bank of Mexico. Bylaw,theNationalOilCompany(Pemex)sellstothecentralbankthedollarsitobtains fromitsexports.Naturally,thecentralbanksterilisesthisoperation.Thisispotentially importantforthefollowingreason.Ontheonehand,fromapartialequilibrium perspectiveandbeingoff-market,thesetransactionsshouldnotbeamatterofgreat concern for our study. On the other, from a general equilibrium perspective, the quantity ofdollarsthecentralbankobtainsfromPemexcouldhaveanimpactonthebanks decisions. In addition, there is a data availability issue. The associated time series are only available on a weekly basis. Thus, we do not use these time series in our analysis. DataTheexchangeratedataarefromReuters.TheReuterssystemdoesnotregisterall peso/dollartransactionsworldwide.Asisthecaseforthevastmajorityofforeign exchangemarkets,thepeso/dollarmarketisratherdecentralised.Thus,althoughthere are systems thatcollect data on a significantportion of the transactions, inevitablysome are not captured. The underlying assumption in the analysis is that the Reuters database is representative of all transactions taking place worldwide. We have data for bids, asks and transactions. A natural question is to what extent a bid or anaskpricereflectsan actualprice.In thisrespect,ifabidoranaskis submittedtothe 012345678dic-03dic-04dic-05dic-06dic-07dic-08dic-09dic-10dic-11dic-12Intervention Type 1. Auction sales of dollars to reducethe accumulation of reserves2. Extraordinary auction sales ofdollars3. Auction sales of dollars with aminimum price4. Auction of dollars without aminimum price5. Dollar credit auction6. Auction sales of dollar options7. Direct sales (discretionary)Episode 1 Episode 2 16 tradingplatform, the partythatsendsitand theone thatrespondsare obligedtofollow throughonthetransaction.10Hence,totheextentthatsomeoneiseitherbiddingor asking,theiractionsarebinding.Thus,thesedatacertainlyconveysomeuseful informationfromtheexchangemarket.Asusedinthispaper,thedatacanconvey information somewhat different from the information contained in the actual transaction price.Giventhatthetransactiondatareflectactualprices,thesearethemost informative.11 There are some additional issues regarding the data. First, some observations were clearly outliers.Thus,whenthatwasthecase,theywereexcludedfromthesampleusingthe followingcriteria.Weestimateaone-quartermovingaverageandstandarddeviationof the exchange rate level. Any datum beyond the plus/minus five standard deviations range is discarded. We restart this process after the SeptemberOctober 2008 depreciation. Second,thebid,askandtransactiondataarenotobservedatequidistantintervals. Nonetheless,equidistantpricesareneededtobeabletoapplystandardeconometric methodology.Inthisregard,wefollowDominguez(2003)intransformingtherawdata intofive-minuteintervaldata.Thekeyideaistoapproximatethepossibleunobserved datumPt,wheretisoneofthefive-minutetimestamps,asafunctionoftheclosest adjacentobservedprices(beitabid,askortransactionprice).Themaindifference betweenDominguezsmethodandtheoneweuseisthat,inourcase,theobservedbid andaskdataareseparatelysetasequidistantprices.Atalaterstage,weestimatethe average bid-ask returns and the bid-ask spread of the exchange rate. We proceed this way because the timestamps for the bid and ask prices in our database do not always coincide. Please refer to Dominguez (2003) for further details.12

10Apossiblevariationiswhenthebidoraskissentwitharestriction.Thisistypicallyassociatedwitha transactionthathasagreaterthanaveragesize.Inthiscase,theamounttransactedmightvary,butthe involved parties are both mutually obliged to complete it. 11 Thereareseveralthingswedonotknow,forinstance,howeverytransactionwasinitiated,theamount involved in each transaction, the order flows, and whether it is a bid or an ask that is associated with a given transaction price. These data would certainly be informative, but we do not have them.12 One of our methods implications is that, to estimate the exchange rate at time t in an equidistant fashion, information after t is used. So, although the data might be used to measure an average effect, as in our case, itwouldbeinadequatetousethemforcertainfinancialmodelsforwhichusingdatastrictlyuptotimet (including t) is important. A case in point is within the context of a financial derivative model. An alternative is to think of the exchange rate at time t only as a function of information available up to time t (including t). As for example, use the price at t when available, and use the price closest to but before t, when the price at tisnotavailable.Still,thevaluesobtainedfromthesemethodsdonotusuallydifferbymorethan1cent from each other. 17 Third, the statistical exchange rate returns are estimated using the returns from the entire dayandfromthetimestampssurroundingtheinterventionhours.Toclarifythispoint, consider the returns of thefive-minute intervals at 08:30 and 08:35. We take these to be thelogdifferencebetweenthepricesat08:25and08:30,and08:30and08:35, respectively.Moregenerally,wehavethatrt=log(Pt/Pt-1),wheret-1,t,t+1,are equidistant.Theconstructionoftheestimationsampleisoneofthekeystepsinaneventstudy.We choosethefollowingsampleaswebelieveitisthemostinformativeand,intandem,it excludessomeirrelevantobservationsthatwouldprobablyonlyaddnoisetothe estimation.ThestudysampleincludesthosedayswheretheType3intervention mechanismwasactive(whichalsocontainsdayswheretheType4interventionwas active). However, the estimation sample only includesthe time windows surrounding the timestampwheretheinterventionsoccurred.Thismeansthat,fromtheentirestudy sample that includes the complete days, we took only specific intervals for each day.Theestimationsamplecanbedividedintotwo:interventionandcontrolsamples.The controlsamplecontainstheobservationsofthetimestampswherenodollarswere allocatedgivenaninterventionassociatedwiththatwindow.Thiscouldhavebeenthe case for one of two reasons. First, there was no auction convened or, second, the auction wasconvenedbuttheamountofdollarsallocatedwaszero.Theinterventionsample contains the rest of the observations, meaning only observationswhich correspond to an intervention time window where dollars were allocated. We think this sample provides good treatment and control samples because it also takes intoaccountthat,whenaType4interventionwasactive,themechanismoftheType3 intervention was also active. Thus, it is likely that the days that could better play a role as a counterfactual to the Type 4 intervention are those days when a Type 3 intervention was activebuttheType4interventionwasnotandnodollarswereallocatedforaType3 intervention.Thesedays,asexplainedabove,arecontainedinthecontrolsample.We incorporatecontrolsaswell,asthesemightplayanimportantroleindeterminingthe exchange rate.Itisworthmentioningthatthesampleonlyincludes dataafterthepesosCLSaccession, an event affecting the exchange rate, as we document below.Goingintoamoredetaileddescriptionofthesample,theestimationsampleisfrom9 October2008to9April2010.Theperiodfrom30Novemberto31December2011is excluded, as Type 3 interventions took place at different times of the day, associated with episode 2.18 Ineffect,wedonotuseepisode2oftheType3interventionsforthreereasons.First, therewasachangeinthetimesofthedaythisinterventionwasimplemented,as mentionedabove.Thus,attemptingtomeasure itseffectandaccountingforthischange mightbeproblematic.Also,thesecondepisodewithinourdatabaseaccountsforavery smallnumberofobservations.Inthesamevein,incorporatingdatafor2012shouldnot makemuchofadifferenceasthattypeofinterventionallocateddollarsonlyonthree daysduringtherelevantyear.Thus,webelieveitismuchmorestraightforwardto concentrate on the first episode and, in terms of information, not much is lost if we do not use the data from the second episode and 2012.Finally, the Type 4interventionwas not activeinthesecondepisodeofType3interventionandthestressintheeconomywas significantly lower than in the period we consider. The intervention sample is drawn from the windows surrounding the interventions from 9 October 2008 to 9 April 2010, when a positive amount of dollars was allocated.Thecontrolsampleisdrawnfromthewindowssurroundingtheinterventionsfrom9 October 2008 to 9 April 2010 and no dollars were allocatedTable 2 presents the number of observations in the total sample, as well as those for the study, the intervention, and the control samples.Table 2 Set of samplesSamplesObservations Total sample622,368 Study sample 102,240 Intervention sample1,439 Control sample9,566 Table3presentsbasicstatisticsforvarioustimeintervalsforthepeso/dollarexchange rate returns for selected samples. The table presents key statistics on the behaviour of the exchangeratereturns,namely,mean,variance,skewness,andkurtosis,atdifferenttime intervals and for various samples.Withrespecttoreturnsdatastatistics,first,inthestudysamplethemeansarenegative anddecreaseasthehorizonincreases,whileintheinterventionsampletheyincreaseas the horizon lengthens. In the case of the control sample, the pattern is less clear, as it has apositivesignforthefirsttwohorizonsandanegativeoneforthesecondtwo.The behaviour of the means should beinterpreted with care, as their estimationis subject to important standard errors. 19 Second,thevarianceincreaseswiththetimeinterval.Thisisinlinewithbasictheory:a higher return is, on average, associated with greater risk.Third, the skewness and kurtosis decrease in absolute value as the time interval increases. Inotherwords,astheintervalincreases,thereturndistributionstendtoanormal distribution. Nonetheless, for each time interval, the distributions are far from exhibiting a normal distribution. Although in some cases the skewness approaches zero, the kurtosis is in all cases relatively large, reflecting heavy tails in the distribution.Fourth,ingeneral,theinterventionsamplevolatilityisgreater thanthe non-intervention sample volatility.Skewnesstendstobepositiveintheinterventionsampleandnegativeinthenon-intervention sample. Thus, the mean tilts above (below) the median on intervention (non-intervention)sample.Fifth,thechangeinkurtosisbetweeninterventionandnon-intervention days is very distinctive: on intervention days it is smaller.In sum, these statistics provide an overview of the changes in the distribution of returns on intervention and non-intervention samples. Yet, based on the samples, it is not possible to identify how far a given change in a statistic on intervention days is due to the intervention itself or due, for example, to the prevalent macroeconomic conditions. This question we explore more closely in the rest of the paper. 20 Table 31, 2 Intraday FX return study sample RateTime intervalMeanVarianceSkewnessKurtosis Observations Transaction MXP/USD5 min-1.48E-076.32E-07-3.758449.711102,240 1 h-1.51E-067.37E-06-0.88654.986102,240 6 h-2.06E-064.34E-050.54022.251102,240 24 h-5.50E-051.69E-040.78214.922102,240 Intraday FX return intervention sample RateTime IntervalMeanVarianceSkewnessKurtosis Observations Transaction MXP/USD5 min3.53E-053.08E-062.234127.3131,439 1 h1.01E-042.14E-05-2.65325.2171,439 6 h5.89E-045.68E-050.1045.6141,439 24 h3.78E-032.23E-040.4796.3221,439 Intraday FX return control sample RateTime IntervalMeanVarianceSkewnessKurtosis Observations Transaction MXP/USD5 min6.45E-061.20E-06-2.835123.1979,566 1 h1.21E-041.29E-05-0.01130.7299,566 6 h-5.13E-046.22E-05-0.7939.4999,566 24 h-7.26E-041.26E-04-0.44812.2119,566 1 We do not observe the convention of subtracting a 3 from the kurtosis. 2 The study sample takes into account the observations for all days; the rest for the timestamps surrounding the intervention hours. Source: Authorsestimations on Reuters data. Measuring liquidity and orderly conditions in the foreign exchange market In this section, first, we briefly explore the concepts of liquidity and orderly conditions. In particular,wediscusshowfarthesecan bemeasured bythebid-askspread.Second,we consider whether there are other factors that might affect the bid-ask spread that are not directly related to the relevant concepts. Inthiscontext,considerthefollowingtwodescriptionsofliquiditytakenfromGalati (2000). First, liquidity is the ability to sell something without discounting its price. Second, inaliquidmarket,largetransactionshaveonlyaslighteffectonprices.Evidently,both definitionshaveacertaindegreeofambiguity.Inthefirst,itisunclearhowonewould determine the relevant price. In the second, it is unclear what is meant by slight. In effect, 21 asDermanpointsout:Noonequiteknowswhatliquidityreallyis,andsothereisno goodmodelofit.[]Peopledefineitbyitsproxiesbid-ask,averagedailyvolume, market impact etc, which are features of but arent actually liquidity itself.13 Thus, we go along with Derman and think of the bid-ask spread as a proxy for liquidity. There is probably no consensus on a common definition of orderly markets. Yet, one can argue that a smallbid-ask spread is a sign of orderly markets. In contrast, a largebid-ask spreadmightinvolveanimbalanceinordersorbroaddisagreementsonthepriceof assets,bothsignsofdisorderlymarkets.Anorderlymarkethaspricesthatreflectthe fundamentalvalueofassets.Thus,increasingamarketsliquidityisawayofobtaining such prices. We use the following definition for the bid-ask spread:

(

) where

and

aretheequidistantaskandbidprices,respectively,ofthe peso/dollar exchange rate at time t. Thus, the bid-ask spread is the percentage difference betweenaskandbidprices.Notethatweusethetermbid-askspreadandspread interchangeably.Table4presentsbasicstatisticsforthefive-minuteintervalbid-ask spread.Severalremarksareinorderhere.First,boththemeanandthevarianceare greater in the intervention sample, as compared to the non-intervention sample. Likewise, the skewness and kurtosis are greater in the intervention sample in comparisonwith the non-intervention sample. Thus, in the intervention sample, the spread distribution has, on average, much heavier tails. In particular, its right tail is heavier. This shows the prevailing uncertainty in terms of liquidity on the days of the interventions.

13 blogs.reuters.com/emanuelderman/. 22 Table 41, 2 Intraday bid-ask spread five-minute interval(percentage) SamplesMeanVarianceSkewnessKurtosisObservations Total sample1.17E-036.74E-0612.88347.22622368 Study sample1.80E-031.59E-0510.62162.73102240 Intervention sample4.58E-041.74E-073.9725.211439 Control sample4.81E-043.70E-0715.25422.839566 1 Thetotal andstudysamplestake into account the observations for all days; the rest for the timestamps surrounding the intervention hours. 2 We do not observe the convention of subtracting three from the kurtosis. Source: Authors estimations on Reuters data. Inwhatfollowsweanalysethetimeseriesofthepeso/dollarbid-askspread.Inthis respect, Figure 5 depicts its evolution in recent years. Three features clearly stand out.(i)On average, an overall narrowing of the spread.(ii)A narrowing of the spread immediately after May 2008.(iii)An increase in the spread after September 2008.Figure 5 Peso/dollar bid-ask spread1 (Price of ask as % of bid) 1 Period: January 2003December 2011. Source: Reuters. Next, we document some of theevents associated with these features. As mentioned, in May 2008, the Mexican peso joined the CLS system and, consequently, the peso started to 23 betradedonthisplatform24hoursaday.Weinferthattheliquidityofthepesohas increasedsincethen.Nevertheless,asisobvious,tradingwasadverselyaffectedbythe recent financial global crisis, starting in September 2008.Toassesswhether theseeventsstatisticallyaffectedthebid-askspread, wetesttoseeif itsmeansandvarianceshavesignificantlychangedintherelevantepisodes.More concretely, for the means we perform a standard t-test, and for the variances we used the Brown-Forsythe test. To this end, we have divided the sample into three subsamples:(i)Before May 2008; (ii)After May 2008 (including May) and before September 2008; and(iii) After September 2008 (including September).ThestatisticsinTable5presentevidenceforthechangingmarketconditionsduetothe above-mentioned events. Table 5 Statistics for the bid-ask spread in selected periodsMeanStandard deviationObservations Jan-03Apr-081.01 x 10-31.88 x 10-3363,744 May-08Aug-084.54 x 10-45.72 x 10-423,904 Sep-08Dec-111.50 x 10-33.49 x 10-3234,720 Source: Authors estimations on Reuters data. Bycomparingthemeansforthefirstandsecondsubsamples,onecanseethisstatistic was greater at least twice asgreat before thepesos entry into CLS. However, by the time the financial crisis erupted, the average bid-ask spread had increased dramatically.The results shown in Table 6 reject the null hypothesis of equality for both the mean and variance,attheusualconfidencelevels.Thesestatisticssupporttheviewthatmarket conditionshavesignificantlychangedsincethepesosCLSaccessionand,asaseparate incident, since the financial crisis started. In effect, most of the interventions of all types in the recent past have taken place after September 2008.24 Table 6 Comparison of bid-ask spreads Means (t-stats)Jan-03Apr-08May-08Aug -08Sep-08Dec-11 Jan-03Apr-08--- May-08Aug -08114.97-- Sep-08Dec-1162.17128.88- Variances (F-stats)Jan-03Apr-08May-08Aug -08Sep-08Dec-11 Jan-03Apr-08--- May-08Aug-081504.02-- Sep-08Dec-115381.631841.36- ToexaminemorecloselytheeffectsofthepesosCLSaccession,wecomparethesame samplewithanalternativecontrolsample.Specifically,weconsidertheMay2007to August2007period,coveringthesameperiodoneyearpreviously,asthiscouldcapture common seasonal components. Table 7 shows the statistics for both samples, while Table 8 presents the tests for the equality for the means and the variances. Table 7 Spreads statistics Basic statisticsMeanStd deviationObservations May-07Aug-074.89 x 10-45.40 x 10-425,056 May-08Aug-084.54 x 10-45.72 x 10-423,904 Table 8 Comparing average spreads in selected periods TestsMeans (T-stat)Variances (F-stat) May-07Aug-07vis--visMay-08Aug-08 6.9831.46 Allinall,itisclearthatthemeanwasreducedaftertheCLSaccession;howeverthe standard deviationisgreaterinthesecondsample.Bothtestsrejectthenullhypotheses ofequalityinmeanand variances,attheusuallevelsofstatisticalsignificance.Thisadds totheevidencethattheCLSaccessionchangedthedynamicsofthepeso,effectively providing the foreign exchange market with more liquidity.Moving on to the evolution of the bid-ask spread at an intraday basis, Figure 6 shows the averageintradaybid-askspreadfordifferentsamples,namely,theinterventionsample (dayswheretherewasanallocationofdollars),studysample(dayswhereoneofthe 25 intervention mechanisms was active), and the total sample (from 2003 to 2011).14 In this regard, several remarks are in order.First, both the intervention sample and the study sample show, on average, higher levels of the bid-ask spread for any time of the day than the total sample. This reflects, in part, thestressfulnatureofthisperiodfortheMexicaneconomy,atthetimewhenthe interventions were made. Second, for most parts of the day, the average spread in the intervention sample is usually lowerthanitscounterpartinthestudysample. Thiscouldbeasignoftheinterventions effectiveness in reducing the bid-ask spread. Third,somecyclicalpatternispresentintheintradayspreadregardlessofthespecific sample considered. The bid-ask spread starts high in the early part of the day, coinciding with the Asian trading session. At that time of the day, some Asian financial markets have been open for some hours; eg by 00:00 (06:00 GMT) the Tokyo Stock Exchange has been openforfourhours.Perhapstheplateauinthebid-askspread,justpastthe20:00(2:00 GMT+nextday)markcanbeassociatedwiththeopeninghoursoftheAsiantrading session.Next,theEuropeanmarketsopen,egGermanyandLondonareopenby02:00 (08:00GMT).Inthisperiod,theaveragebid-askspreadstartstoslowlynarrow.As mentioned, the Mexican Stock Exchange opens at08:30 (14:30 GMT) and closes at 15:00 (21:00 GMT), which coincides with the opening of the NYSE. By 05:30 (11:30 GMT) there is aclearincrementintherateatwhichthebid-askspreadnarrows.Laterintheday,at 12:00 (18:00 GMT), So Paulo opens, an event that does not seem to affect this rate.Thus,theafternoonAsiantradingsessioncoincideswiththemorningEuropeansession, whiletheafternoonEuropeansessioncoincideswiththeAmericasmorningsession.The bid-askspreadreaches,onaverage,itslowestlevelbetween07:30(13:30)and13:00 (18:00), with marked relatively high levels at the end of the day.

14 Note that the study sample contains the intervention sample. 26 Figure 6 Average peso/dollar intraday bid-ask spread for different samples (Price of ask as % of bid) Notes: GMT. Source: Authors estimations on Reuters data. First, regardless of intervention status, the average value of the bid-ask spread starts high intheearlyhoursoftheday,beforenarrowingandreachingaminimumaround07:30 (13:30 GMT). It stays at around the same level for approximately the next six hours. Then, towardstheendoftheday,ataround15:00hours(21:00GMT),itmarkedlyincreases. Thesedynamicsarepotentiallyaffectedbytheopeningandclosingoffinancialmarkets around the world. Second, on average, the intervention mechanism was implemented on the days on which it was most needed, when liquidity was low, as measured by the higher average bid-ask spreads of the study and intervention samples.Third, during the times when the interventions occur (ie between 09:00 (15:00) and 13:00 (18:00GMT/MexicoCitytime),theredoesnotseemtobeastrongseasonaldaily component,asthespreadstaysonaverageatthesamelevel.15Thus,theuseofa seasonalcomponentintheregressionsdoesnotseemtobewarranted.Fifth,although this analysis is relevant in its own right, what is pertinent to us is any possible implication that could affect the construction of the intervention samples and, in particular, the non-intervention samples. Thus, it iskey to realise that themain two changes documented in

15 In GMT time, the interventions occur between 14:00 and 20:00. The GMT time interval is larger than the Mexico City time interval because summer time is observed in Mexico.0.0E+005.0E-041.0E-031.5E-032.0E-032.5E-033.0E-033.5E-034.0E-0300:0000:5001:4002:3003:2004:1005:0005:5006:4007:3008:2009:1010:0010:5011:4012:3013:2014:1015:0015:5016:4017:3018:2019:1020:0020:5021:4022:3023:20Intervention sampleTotal sampleStudy sample27 thissection,namelythepesosCLSaccessionandtheglobalfinancialcrisis,tookplace prior to the intervention and non-intervention samples. General considerations The canonical model is as follows:

Where, abusing notation,

stands for the bid-ask spread on time period t and on day i, mfortheperiodsbefore,atoraftertheintervention.D(k)standsfortheinterventionk variable, Xt stands for the control variables, and both might be constructed as dummies or as standardised variables, which reflect the amount of dollars allocated in the auction.16

As previously discussed, in measuring the effect of the interventions on the spread, a key assumption is the construction of the control sample. In this context, the essential idea is toconsiderthemostsimilardayspossible,inwhichnodollarswereallocated.Thisis,of course, challenging, as a similar period would most probably entail an actual intervention, just as a similar condition would probably trigger an auction and/or cause the participants todemanddollars.Inaddition,thecontrolvariablesaccountfortheunavoidable differences between the referred samples, and thus they should be carefully selected. WeusedtheVIX,theso-calledfearindex,asacontrolvariableinsomeofour specifications. In this, we seek to account for the macroeconomic uncertainty prevailing in the time period considered. Although this is an imperfect measure, it does to some extent capture the actual macroeconomic conditions.17 We use the GMM posited as a just-identify system and with the weighting matrix equal to the identity. This accounts for possible heteroscedasticity and autocorrelation in the error term. We assume that the autocorrelation has a lag of three periods. Therearetwoeconometricissuesthatareofconcern,namely,simultaneityand endogeneity.Asiswellknown,thesecanintroducebiasesinanyofourestimates.The presence of potential simultaneity can best be seen by recalling the triggering mechanism oftheauction.Iftheexchangeratedepreciatedbymorethan2%fromonedaytothe

16Westandardisedaseriesbysubtractingfromeachcomponentthemeananddividingitbythestandard deviation of the forecasted value. This could also be done with the historical mean and standard deviations. We prefer to use the former, as they should reflect more closely what is expected by the market participants compared to historical estimates.17 We use the VIX on a daily basis due to data availability. However we use a daily lag to avoid using future informationcontainedinthecontemporaneousdailyVIXasthisindicatormightcontainintraday information that became available after the time windows considered. 28 next, then an auction is convened for a Type 3 intervention. Thus, if the bid-ask spread is correlatedwithsuchabruptchangesintheexchangerate,thensimultaneitymightbe present.ApossiblewayofdealingwithsimultaneityforaType3interventionisto approximate a response function based on the triggering rule for the auction. This would alleviate the simultaneity issue. On the effectiveness of interventions Anassessmentofinterventioneffectivenessdependsonthechoiceofframework.From the quantitative benchmark to the choice of the control sample and the control variables, everyconstituentinfluencestheresults.Whatismore,centralbanksprovidenoexact meansofevaluatinganinterventioninthesensethattheircommuniqusdonot necessarily translate into a quantitative benchmark measurement.Acloselyrelatedissueisthattheliteraturehasdifferentiatedbetweenthestatedand perceivedaimsofanintervention.Forthepurposesofthispaper,wetakeasgiventhat the perceived aim is the same as the stated one. In the specific case of thecommuniqu associated with a Type 3 intervention, it is stated that: the objective of this mechanism is to provide the necessary liquidity to meet the conditions of uncertainty and lack of liquidity in the foreign exchange market. It has been our own choice to use the bid-ask spread as a yardstick. A simple modelTobeginwith,weconsiderthefollowingmodel,aregressionthataimstocharacterise (perhapsinasimplemanner)thebehaviourofthebid-askspreadwhenanintervention takes place. The model is:

where:

is the bid-ask spread on day t and at time i.

is the intervention k variable, k could be intervention Type 3 or 4. As explained above,thiscanbeadummyorastandardisedquantity.Todetailthenotation, supposethat thisisa dummy.Thus,supposean intervention takesplaceonday t at time i. m determines the lag or lead with respect to the intervention time, ie m goes from20minutesto+20minutes,infive-minuteintervals.Then,D(k)t,i,m=1ifthere wasaninterventionkondaytandattimei,(onthetimewindowoflength40 minutessurroundingtheinterventiontimei).OrD(k)t,i,m=0ifnodollarswere 29 allocatedondaytattimei.Thiscanalsobeconstructedasthequantityofdollars allocated on day t at time i. The rest is defined analogously. First,observationsoninterventionsandcontroldaysoutsidethewindowsareexcluded. Webelievethesedataareuninformative.Second,threeinterventionstakeplaceona Type 3intervention day(or four in totalif a Type 4intervention is also active). Thus, this regressionbundlesthemtogethersincethescoefficientsaccountforthetimebefore, at, and after the intervention and not the specific time of the day. Thus, for instance, 10 is only associated with the effect 10 minutes after the intervention, regardless of the actual timeoftheintervention.Inshort,thecoefficientsarerelativetothetimeofthe intervention,asopposedtoabsolute.However,thecoefficientsassociatedwithaType 4 interventionarereportedseparatelysincetheycannotbebundledwiththerestastheir aim and active period are different. Wementionedthatitissimplertouseonlytheinterventionvariable,beitadummyor thequantityofdollarsallocated,sincetheinterventionsampleandthecontrolsample would differ in many other aspects that are not captured by the intervention variable. The inclusionofcontrolvariablesiswarranted,orattheveryleastitisrelevanttoexplore their effects on the coefficients estimates associated with the intervention. Controls Ourbasicestimationuses12USmacroeconomicindicatorsascontrolvariables.These macroeconomicindicatorsareconstructedintwodifferentways.First,asdummy variablesdefinedintermsofsurprises.Thesetrytocaptureunexpectedchangesinthe economy. Second, they are also constructed as standardised variables. This is very much in thespiritofthefirstexercisebut,inaddition,takesintoconsiderationthesizeofthe intervention. They could affect the exchange rate, above and beyond the direct effects of the interventions themselves. If any change is expected, we assume it has been accounted for in the exchange rate.Uptothispoint,wehavedecidednottouseMexicanmacroeconomicvariablesas controlsforthreereasons.First,anecdotalevidencefromtraderspointstocertainUS macroeconomicvariablesasthemostimportantdeterminantsoftheexchangerate. Second, casual observation and previous research has established the variables we use as importantdeterminantsoftheexchangerate.Third,theiruseisvaluableintermsof allowingustocompareourresultswithotherstudiesintheBISCCAResearchWorking Group. At the same time, we certainly acknowledge that they might be relevant and plan to incorporate them in future research.30 The macroeconomic variables considered are:1.Consumer Confidence 2.Consumer Price Index (CPI) 3.Durable Goods 4.Housing Starts 5.Industrial Production 6.Producer Price Index (PPI) 7.National Association of Purchasing Managers Index (NAPM) 8.Retail Sales 9.GDP 10.Unemployment 11.Trade Balance 12.Federal Funds Rate Bloomberg,thesourceforthesedata,providesinformationaboutthemarkets expectationsintheformofsurveys.Eachsurveyasksforecastingprofessionalsfortheir prediction for the variable at hand. Using these data, we construct surprises as follows:

{

|

| where:

isavariablethatidentifiesasurpriseeventattimet.Sincethespread typically increases regardless of the sign of the surprise, we use the absolute value.

is the value of one of the macroeconomic variable at hand at the time of its release, denoted by t,

isthemedianvalueofthesurveythatreferredtothe announcement of one of the indicators at time t, and

isthestandarddeviation,whichisapproximatedbytakingthedifference between the maximum value and the minimum value of the survey, divided by six. Thisapproximationofthestandarddeviationwasusedbecausewecouldonly obtainthehistoricalseriesofthemaximumvalue,theminimumvalue,andthe median of the forecasts.18 For each definition, the a denotes the type of announcement.

18Analternativewastoestimatethestandarddeviationofthetimeseriesofthevariable,yetwebelieve using the information in surveys is a more accurate description of the surprises. 31 Inthesecondcase,we usetheabsolutevalueofthesame macroeconomicvariablesbut standardise them as follows.

|

|Inthethirdcase,weuseadummythatcontrolsfortheType4intervention.Thisis importantforthreereasons.First,thistypewasimplementedwhileType3wasbeing deployed. Second, it is designed with a more flexible auction. The key difference is that its auction has no minimum price.The model estimated in this case is:

Where:

is the five-minute interval bid-ask spread on day t and at time i+m.

is the intervention k variable, k could be a Type 3 or Type 4 intervention. The description is the same as in the simple model.19

is the newssurpriseannouncementdummy.Say,a newsannouncement takesplaceondaytandattimei(thus,icanbe09:30,11:30or13:00),mthen determines the lag and lead with respect to the news announcement time. m goes from 20 minutes to +20 minutes, with five-minute intervals. Then, DNa,t,I,m = 1 if it isasurprisenewsannouncementondaytofkindaattimei+m,ieonthetime window of 40 minutes duration surrounding the intervention. Finally, DNa,t,i,m = 0 if thereisnosurprisenewsannouncementondayortimet.Asmentioned,thea denotes the type of announcement, ie a =1, 2, 3, ..., and 12. Also,sincethetimeofmanynewsannouncementsisearlierthan09:10,weextendthe intervalsofthedaysconsideredaccordingly.Forexample,ifthereisanews announcementat07:30,weconsiderdatastartingfrom07:10.Infact,datacanstartat any point from 07:10 to 14:35, as 07:30 is the earliest time and 14:15 is the latest time for a news announcement in our database.In this respect, Figures 7 to 10 present, for each window, the coefficients

associated withtheinterventiondummiesand, ,asfunctionsofm,relatedtothenews announcements dummiesforthemacroeconomicannouncements.Fortheestimation of

19 As mentioned before,observations on interventions andnon-intervention days outside the windows are not included. We believe these data are uninformative.32 thestandarderrorsofthesepartialsums,thecovariancebetweeneachpaircoefficients needs to be taken into consideration. Several remarks are in order. First, the coefficients associated with the Type 3 intervention in thebasic estimation for different specifications are significantly positive. However, the estimatedcoefficientsofalternativemodelsthatusetheVIXasacontrolarenot significant.Thus,thesignificantcoefficientsofthebasicestimationmaybesimply associatedwiththefactthatthespreadinthefirstpartoftheinterventionsamplewas larger than in the control sample, as noted by Figure 5, just after the Lehman bankruptcy. Second,thecoefficientsassociatedwiththeType4interventionare,forthesimple specifications, negative and significant, both statistically and economically. For example, in Figure7,thereisanaverageeffectof1.2x10-4.Lookingattheaveragevalueofthe spread for the study sample, 1.8 x 10-3, the effect of the intervention could account for a reductionof6.66%oftheaveragespreadlevelforthatperiod.Evenmore,theresult seems robust even when we account for the VIX as a control variable. Third,thepartialsumoftheannouncementscoefficientsisgreaterinmagnitude, comparedtotheinterventioncoefficients,asmeasuredbytheleftaxis.Thisshouldnot come as a surprise as it is the aggregate effect of all12 macroeconomic announcements. Yet, for some specifications the effect on the spread of a single macroeconomic surprise is roughlythesameinmagnitudeastheinterventionscoefficients.20However,asitis showninFigures8to10,veryfewcoefficientsassociatedwiththeannouncementsare significant,particularlyaftercontrollingfortheVIX.Theonlyparticularrobusteffectis that at the time of the macroeconomic surprise, the spread is significantly larger.Intermsofthemagnitudeoftheeffect,theaverageeffectofasinglesurpriseina macroeconomic indicator is around 2.5 x 10-4. The size of the effect is then approximately 13.9%oftheaveragebid-askspreadoftheinterventiondays.Thus,theseestimatesare statistically and economically significant.

20Thesewillonlyholdforsomespecifications,inparticulartheonesthatusedummiesbothforthe interventionsandfortheannouncements,allowingthemagnitudeofthecoefficientstobecompared.In cases where the variables used are the intervention amounts and the standardised news, these equivalences are not so easily obtained. Also, this should be interpreted cautiously, as the exchange rate may be reacting toaparticularannouncementandthiscouldbethemaindriveroftheaggregateeffect.Adisaggregated comparison of the 12 indicators should be made to see the particular effect of a single announcement. We do not present such analysis here as it is outside the scope of this paper. 33 Figure 7 Before and after responses to interventions and macroeconomic announcements: Dummies Type 3 interventionType 4 interventionMacroeconomic announcements Intervention dummies, macroeconomic dummies Figure 8 Before and after responses to interventions and macroeconomic announcements: Intervention amounts and standardised announcements Type 3 interventionType 4 interventionMacroeconomic announcements Intervention amounts, macroeconomic standardised announcements -2.0E-040.0E+002.0E-044.0E-046.0E-048.0E-041.0E-03-00 : 20-00 : 1000 : 0000 : 1000 : 20-2.0E-04-1.6E-04-1.2E-04-8.0E-05-4.0E-050.0E+00-00 : 20-00 : 1000 : 0000 : 1000 : 20-1.0E-030.0E+001.0E-032.0E-033.0E-034.0E-035.0E-036.0E-03-00 : 20-00 : 1000 : 0000 : 1000 : 20-1.0E-060.0E+001.0E-062.0E-063.0E-064.0E-06-00 : 20-00 : 1000 : 0000 : 1000 : 20-2.5E-06-2.0E-06-1.5E-06-1.0E-06-5.0E-070.0E+00-00 : 20-00 : 1000 : 0000 : 1000 : 20-5.0E-040.0E+005.0E-041.0E-031.5E-032.0E-03-00 : 20-00 : 1000 : 0000 : 1000 : 2034 Figure 9 Before and after responses to interventions and macroeconomic announcements: Dummies; using the VIX as a control Type 3 interventionType 4 interventionMacroeconomic announcements Intervention dummies, macroeconomic dummies, VIX Figure 10 Before and after responses to interventions and macroeconomic announcements: Intervention amounts and standardised announcements; using the VIX as a control Type 3 intervention Type 4 intervention Macroeconomic announcements Intervention amounts, macroeconomic standardised announcements, VIX -4.0E-04-2.0E-040.0E+002.0E-044.0E-046.0E-048.0E-04-00 : 20-00 : 1000 : 0000 : 1000 : 20-1.6E-04-1.2E-04-8.0E-05-4.0E-050.0E+004.0E-05-00 : 20-00 : 1000 : 0000 : 1000 : 20-1.0E-030.0E+001.0E-032.0E-033.0E-034.0E-035.0E-036.0E-03-00 : 20-00 : 1000 : 0000 : 1000 : 20-1.0E-060.0E+001.0E-062.0E-063.0E-06-00 : 20-00 : 1000 : 0000 : 1000 : 20-2.5E-06-2.0E-06-1.5E-06-1.0E-06-5.0E-070.0E+005.0E-07-00 : 20-00 : 1000 : 0000 : 1000 : 20-4.0E-040.0E+004.0E-048.0E-041.2E-031.6E-032.0E-03-00 : 20-00 : 1000 : 0000 : 1000 : 2035 Insum,thisevidenceisnotrobustenoughtosuggestthataType3interventionhasan oppositeeffecttotheoneintended.Wefoundsomepositivesignificantcoefficients; however, their significance is not robust to different specifications. This does not allow us to make any conclusive argument regarding the effect of this interventionon thebid-ask spread.Second,theeffectofaType4interventionappearsto berelatedtoasignificant reduction of the bid-ask spread.Thedifferentresultsshownbytheexercisescouldbepotentiallyexplainedbytheir differentdesignsandthedifficultyofassessingthembymeansofthesametypeof exercise. For instance, the Type 4 intervention was triggered regardless of the condition of themarketanddidnothaveaminimumprice.Thiscouldhelpprovidecleaner econometricalresults.Ontheotherhand,theType3interventionhadaminimumprice and, even when the mechanism was active, the auction may not have been triggered. The rulethatdeterminedthetriggeringwasknownbythemarketparticipants;thus,they knewwhethertherewasgoingtobeanauction,andhencethesurpriseoftheactual auction may not have been too large. However, it is easily conceivable that every market participant would have perfect information about its own future actions, but would ignore thepositionsofotherpotentialauctioneers.Thiscouldinducesomekindofsurprisefor theType3intervention.Weacknowledgethisissueandsuggestthatitshouldbe addressed by future research. Final remarks To sum up, our results show no indication of aneffect in the opposite direction from the oneintendedfortheType3intervention,buttheydofavouraninterpretationthatthe Type4interventionwaseffective.Thesemixed resultssuggestthatthe differentdesigns ofthevariousinterventionstypecouldplayanimportantroleinexplainingthe effectiveness of each one. The recent growth of the peso/dollar market could account for the observation that the more passive interventions have a smaller effect than before. Second, there is evidenceto support the idea that macroeconomic surprises increase the bid-ask spread in an economically significant way. This is in line with the related literature. Third, we make two key remarks regarding the simultaneity issue and the measurement of theinterventioneffects.Onecouldconcludethattheauctionmattersforthe interventions effectiveness. This might be the case. Yet it might also be the case that the differenceiseconometricalinnature.Inessence,whiletheType3interventions triggeringmechanismisafunctionoftheexchangerate,thisisnottrueoftheType4 intervention.Thus,inthisrespect,themeasurementofbothinterventionsfromthe econometric point of view is crucial and this might well explain the different estimates.36 Finally,wewouldliketounderscorethatthequantitativebenchmarkweusedfor assessingtheinterventionseffectshasbeenpositbyusandtothatextentissubjectto somearbitrariness.Perhaps,theCentralBankusesotheryardsticksinassessingeach interventions effectiveness which we are not aware of. 37 References Archer,D(1999):Foreignexchangemarketintervention:methodsandtactics,BIS Papers, no 24, May. 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