Foreign Exchange Intervention with UIP and CIP Deviations

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ID: 324264
2026
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Abstract
Abstract We examine the welfare-based opportunity cost of foreign exchange (FX) intervention when both CIP and UIP deviations are present. We consider a small open economy that receives international capital flows through constrained international financial intermediaries. Deviations from CIP come from limited arbitrage or through a convenience yield, while UIP deviations are also affected by global risk. We show that the sign of CIP and UIP deviations may differ for safe haven countries. We find that FX reserves may provide a net benefit, rather than a cost, when international intermediaries value the safe-haven properties of a currency more than domestic households. We show that this has been the case for the Swiss franc and the Japanese Yen. We examine the optimal policy of a constrained central bank planner in this context.
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Authors Philippe Bacchetta, Kenza Benhima, Brendan Berthold
Journal The Review of Economic Studies
Year 2026
DOI
10.1093/restud/rdag085
URL
https://academic.oup.com/restud/advance-article-pdf/doi/10.1093/restud/rdag085/70506127/rdag085.pdf
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