Foreign exchange markets display regularly severe bubbles. This paper explores whether or not the so-called target zone interventions
are an effective tool for central banks to stabilize the exchange rate. We define such intervention operations as buying/selling
an undervalued/overvalued currency when the distance between the exchange rate and its fundamental value exceeds a critical
threshold value. On the basis of a nonlinear empirical exchange rate model with chartists and fundamentalists, we find that
not only target zone interventions have the power to reduce misalignments but also to earn profits.
Keywords Foreign exchange markets - technical and fundamental analysis - heterogeneous agents - central bank interventions
The idea of this paper was born during the 2003 Complexity Workshop in Aix-en-Provence and the Viennese Workshop on Optimal
Control, Dynamic Games, and Nonlinear Dynamics. The paper was presented at the International Conference on Computing in Economics
and Finance in Amsterdam and at the Erich-Schneider research seminar at the University of Kiel. We thank Richard Day, Herbert
Dawid, Cars Hommes, Blake LeBaron, Thomas Lux, Erik Mosekilde, Barkley Rosser and Jan Tuinstra for stimulating discussions.
Also, we thank two anonymous referees and Christophe Deissenberg for helpful comments.