This paper suggests a plausible microstructural connection between rational speculative activity and exchange rate volatility. When Friedman (1953) claimed that rational speculators must smooth exchange rates, he excluded interest rate differentials from his interpretation of speculator behavior. Informed, rational speculators who consider interest differentials will magnify the exchange rate effects of interest shocks and could increase overall exchange rate volatility. This connection between speculators and volatility, which does not rely on asymmetric information, is structural because speculators affect the exchange rate’s generating process. Rational speculation is stabilizing at low levels of speculative activity and destabilizing at high levels. (J.E.L. codes F31, G12.

Using simulation and analysis we show that agent-based auction-cleared automated markets can be stabilized using only completely myopic agents (without value traders), if these naïve agents are provided with a price signal that reflects order-book information. This demonstrates that information in the order book is extremely valuable, that prediction can be replaced by better instantaneous information about others’ bids, and suggests new, more stable algorithms for market-based control.

We are grateful to colleagues in the Reserve Bank's International Department for useful comments and suggestions, and to Peter Kerr for able research assistance. The views expressed in this draft are those of the authors; no responsibility for them Since the float of the Australian dollar in December 1983, the Reserve Bank has intervened in the foreign exchange market in order to exert a stabilising influence. Whether this intervention has been stabilising cannot be directly observed since the behaviour of the exchange rate in its absence cannot be known. However, there are a number of ways of assessing it indirectly. The best known is the Friedman "profits test". Friedman (1953) argued that a central bank which was stabilising the exchange rate would tend to buy foreign exchange when its price was low, and sell when its price is high, and hence its operations would be profitable. This paper applies the profits test to the Bank's foreign exchange operations since the exchange rate was floated. The main conclusion is that over this period the Bank's foreign exchange operations have produced total profits of around $A3.4 billion, suggesting

I would like to thank Amit Bhaduri for his helpful comments on an earlier draft of this paper. The Levy Economics Institute Working Paper Collection presents research in progress by Levy Institute scholars and conference participants. The purpose of the series is to disseminate ideas to and elicit comments from academics and professionals. The Levy Economics Institute of Bard College, founded in 1986, is a nonprofit, nonpartisan, independently funded research organization devoted to public service. Through scholarship and economic research it generates viable, effective public policy responses to important economic problems that profoundly affect the quality of life in the United States and abroad.

Abstract: This study presents evidence on risk-adjusted profits for the Swedish central bank. Estimated profits can be quite sensitive as to whether rates of return are risk-adjusted or not, and how the risk-adjustment is done. Various ways of adjusting for abnormal returns, and extracting buy-sell signals, are tried. Results, on daily data, support the view that Riksbank intervention did not make risk-adjusted losses over the period 1986-1990. The results might be challenged as arising from inappropriate risk adjustment. *The Riksbank has classified some of the data series this paper uses.