FX interventions and capital-constrained banks : evidence from USD/ILS spot, forward, and option markets

Abstract

Using confidential daily data, we examine the Bank of Israel's foreign exchange interventions from 2013 to 2019. We find that a 1 billion U.S. dollars (USD) purchase leads to a 0.82% depreciation of the Israeli Shekel (ILS)–a strong effect compared to other studies. We show that this effectiveness can partially be attributed to the limited risk-taking capacity of global banks. The interventions also widen the negative deviation from covered interest parity and influence the higher-order moments of risk-neutral expectations derived from options prices. We find that USD purchases shift the USD/ILS distribution upward and reduce crash risk. Moreover, the options market anticipates and prices in upcoming interventions.