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1998 was a period of unprecedented volatility for the yen/dollar exchange rate. To help to assess market participants' views on exchange rate developments, the Bank of England uses a range of techniques that employ information from the over-the-counter (OTC) currency options markets. This article describes these techniques and shows how they can be used to assist our understanding of market perceptions of the yen/dollar exchange rate over this period.
Introduction
The exchange rate for the Japanese yen against the US dollar fluctuated widely during 1998, as shown in Chart 1. The yen depreciated from Y131 on 1 January to Y147 on II August, an eight-year low against the dollar.(2) But it then appreciated by 14% on 6-8 October, reaching Yl 11. The yen/dollar rate ended the year at Y114 intraday. The appreciation of the Japanese yen on 6-8 October was its largest two-day move since it began to float in February 1973, as a result of the collapse of the Bretton Woods agreement. Prior to this appreciation, US interest rate expectations had been declining since the Federal Reserve's interest rate cut on 29 September: the March 1999 three-month eurodollar futures contract suggested that investors were expecting a further fall of 50 basis points before expiry. As the yen began to appreciate, the unwinding of large yen `carry trades'3) exacerbated its rise. Some market comment at the time suggested that the moves were not expected to persist. We describe below what we can infer from derivatives markets about these expectations.
There were also two major interventions by the monetary authorities to support the yen in 1998. On 9 April, the Japanese government announced the largest-ever fiscal package, comprising Y12 trillion of spending and Y4 trillion of tax cuts. This was followed by intervention by the Bank of Japan later in the day. On 10 April, a bank holiday for most Western markets, the Bank of Japan intervened again; the yen appreciated against the dollar from F132 to Y128 during Tokyo trading, but fell back over the next few days to its pre-intervention level. The second major intervention to support the yen was conducted in conjunction with the US Federal Reserve on 17 June. The yen appreciated from Y143 to Y137 on the day, but by...