Central bank interventions and exchange rates: an analysis with high frequency data

We use high frequency data for the mark–dollar exchange rate for the period 1992–1995 to evaluate the effects of central bank interventions on the foreign exchange market. We estimate an unobserved component model that decomposes volatility into non-stationary and stationary parts. Stationary components in turn are decomposed into seasonal and non-seasonal intra-day parts. Our results confirm the view that interventions are not particularly effective. The exchange rate moves in the desired direction for only about 50% of the time, and often with a substantial increase in volatility. The model suggests that the two components, which are affected the most by interventions, are the permanent and the stochastic intra-day.     

Exchange rates,interventions, and the predictability of stock returns in Japan

Using monthly Japanese data for the period 1991–2005, we examined the link between exchange rate movements and stock returns. We found that exchange rate movements per se do not help to explain stock returns. There is, however, evidence of in-sample predictability if one accounts for the interventions of the Japanese monetary authorities in the foreign exchange market. This evidence does not indicate a violation of market efficiency insofar as investors cannot use information on interventions to systematically improve the performance of simple trading rules based on out-of-sample forecasts of stock returns.     

Public information releases, private information arrival and volatility in the foreign exchange market

This paper estimates the impact of market activity and news on the volatility of returns in the exchange market for Japanese Yen and US dollars. We examine the effects of news on volatility before, during and after news arrival, using three categories of news. Market activity is proxied by quote arrival, separated into a predictable seasonal component and an unexpected component. Results indicate that both components of market activity, as well as news releases, affect volatility levels. We conclude that both private information and news effects are important determinants of exchange rate volatility. Our finding that unexpected quote arrival positively impacts foreign exchange rate volatility is consistent with the interpretation that unexpected quote arrival serves as a measure of informed trading. Corroborating this interpretation is regression analysis, which indicates that spreads increase in the surprise component of the quote arrival rate, but not in the expected component. The estimated impact of a unit increase in unexpected quote arrival and the range of values observed for this variable imply an important volatility conditioning role for informed trading.     

Interventions in the Yen–dollar spot market: A story of price,volatility and volume

We test the effectiveness of Bank of Japan (BOJ)’s foreign exchange interventions on conditional first and second moments of exchange rate returns and traded volumes, using a bivariate EGARCH model of the Yen/USD market from 5-13-1991 to 3-16-2004. We also estimate a friction model of BOJ’s intervention reaction function based on reducing short-term market disorderliness and supplementing domestic monetary policy. Important finding of this study are that: (i) we find ineffectiveness of BOJ interventions in influencing exchange rate trends pre-1995, in general, but effectiveness post-1995; (ii) FED intervention amplified the effectiveness of the BOJ transactions; (iii) interventions amplified market volatility and volumes through a ‘learning by trading’ process; (iv) BOJ’s interventions were based on ‘leaning against the wind’ motivations on the exchange rate trend and volumes; and (v) BOJ interventions were vigorously used in support of domestic monetary policy objectives post-1995. Though some of our findings confirm recent studies, our analysis goes deeper to provide new findings with important implications for central banks and foreign exchange market participants.     

What drives Yen interventions in Tokyo?: Do off-shore foreign exchange markets matter more than Tokyo market?

We investigate the Bank of Japan's (BOJ) Yen interventions for the period 13 May 1991 to 16 March 2004. The previous literature has been hampered by the coarse daily data and has been unable to identify intervention determinants beyond some embodiment of the first moment of Yen returns. We consider both lagged overnight off-shore (London and New York) and intradaily on-shore (Tokyo) market developments for their heterogeneous influences on the BOJ's intervention decisions. Using a friction model to estimate the reaction function, we find that the interventions were leaning against the wind during the Tokyo hours, in general. Prior to June 1995, there were significant responses to previous day's intradaily Yen returns and volatility. Post-1995, we report a broadening in the BOJ's monitoring to include overnight off-shore Yen returns until Dec 2002 and a broader measure of market disorderliness measured as a transactions cost band in one-month covered interest rate parity condition since Jan 2003. Moreover, there is some evidence that the BOJ secretly leaned into the wind in response to Yen depreciations during the recent period of 2003–2004.     

Volatility and correlation in international stock markets and the role of exchange rate fluctuations

This paper develops a direct, explicit model for the role of exchange rate fluctuations in international stock markets and examines how and to what extent volatility and correlations in equity markets are influenced by exchange rate fluctuations. Evidence presented in this paper indicates that a higher foreign exchange rate variability mostly increases local stock market volatility but decreases volatility for the US stock market. The extent to which stock market volatility is influenced by foreign exchange variability is greater for local markets than for the US market, due to the fact that exchange rate changes are more strongly correlated with local equity market returns than the US market returns. We find that a higher exchange rate fluctuation marginally decreases the US/local equity market correlation. While exchange rate fluctuations held a relatively large fraction of the variation in local stock market returns, there was no significant influence on the US/local equity market correlation.     

Quantile forecasts of daily exchange rate returns from forecasts of realized volatility

Quantile forecasts are central to risk management decisions because of the widespread use of Value-at-Risk. A quantile forecast is the product of two factors: the model used to forecast volatility, and the method of computing quantiles from the volatility forecasts. In this paper we calculate and evaluate quantile forecasts of the daily exchange rate returns of five currencies. The forecasting models that have been used in recent analyses of the predictability of daily realized volatility permit a comparison of the predictive power of different measures of intraday variation and intraday returns in forecasting exchange rate variability. The methods of computing quantile forecasts include making distributional assumptions for future daily returns as well as using the empirical distribution of predicted standardized returns with both rolling and recursive samples. Our main findings are that the Heterogenous Autoregressive model provides more accurate volatility and quantile forecasts for currencies which experience shifts in volatility, such as the Canadian dollar, and that the use of the empirical distribution to calculate quantiles can improve forecasts when there are shifts.     

Central bank FOREX interventions assessed using realized moments

This paper assesses the impact of G3 official central bank interventions on daily realized moments of DEM/USD exchange rate returns obtained from intraday data, 1989–2001. Event studies of the realized moments for the intervention day, the days preceding and following the intervention illustrate the shape of this impact. Rolling regressions results for an AR(FI)MA model for realized moments are used to measure the impact and its significance. The analysis confirms previous empirical findings of a temporary increase of volatility after a coordinated central bank intervention. It highlights new findings on the timing and the temporary nature of the impact of coordinated interventions on exchange rate volatility and on cross-moments between foreign exchange markets.     

Impact of exchange rate regime reform on asset returns in China

Employing monthly data over the period 1999–2010, this paper examines the impact of China's exchange rate regime reform in July 2005 on three major asset markets: house, land, and stocks. We test whether the reform, which switches from a fixed exchange rate regime to a managed floating one, has brought forward structural changes to asset return dynamics. The results suggest that the exchange rate regime switch exerted the most significant impact on house and land returns at the national level, in terms of both returns and their volatilities. In contrast, its impact on China's stock market was moderate, with no structural change being detected in its returns and only weak structural change being found in the dynamics of its volatility. We also find that in comparison with other popular explanatory variables, broad money supply and inflation have the largest explanatory power on housing and land returns in China after the policy reform.     

Is foreign exchange intervention by central banks bad news for debt markets?: A case of Reserve Bank of Australia's interventions 1986–2003

We investigate the effects of the Reserve Bank of Australia's foreign exchange interventions on the USD/AUD market and 90-day and 10-year interest rate futures markets for the period July 1986–December 2003. Using recently released revised and updated intervention data, we investigate contemporaneous and disaggregated intervention influences and find significant evidence for (i) intervention effectiveness in moderating the contemporaneous exchange rate movements especially if interventions were cumulative and large, (ii) exchange rate volatility reducing effect with a day's lag, (iii) undesirable interest rate movements following interventions in some periods compromising monetary policy effectiveness, and (iv) a volatility reducing effect of cumulative interventions in the 90-day rate, and a volatility increasing effect of large interventions in both the 90-day and 10-year rate futures. These findings are a unique and significant contribution to the prevailing literature as they demonstrate that the RBA's interventions matter not only for the foreign exchange market but also for the debt markets.     

A test of the stability of exchange rate risk: Evidence from the Australian equities market

This paper investigates the sensitivity of equity returns on Australian industry portfolios to an exchange rate factor for the period 1988–1998. Specifically, using daily data, we (1) analyse the exchange rate exposure of the Australian equities market by implementing a basic augmented market model using relevant bilateral exchange rates, (2) investigate the intertemporal stability of the exchange rate exposure by using a dummy variable specification, and (3) attempt to establish the determinants of the exchange rate exposure of Australian industries by undertaking a cross-sectional analysis. A further empirical issue addressed by our study is that of whether the sensitivity is contemporaneous or lagged. We find (a) some evidence of exchange rate exposure, (b) some evidence of intertemporal sensitivity, and (c) a greater sensitivity to movements in the Australian dollar/US dollar exchange rate factor than to movements in the Australian dollar/Japanese yen. Further, we observe a significant lagged effect when employing the basic augmented model. This difference in the response of the industry portfolio returns is not observed, however, in our intertemporal stability investigation. Finally, we do not find significant evidence in terms of the cross-sectional determinants of foreign exchange exposure.     

Asymmetric volatility in the foreign exchange markets

We examine the presence or absence of asymmetric volatility in the exchange rates of Australian dollar (AUD), Euro (EUR), British pound (GBP) and Japanese yen (JPY), all against US dollar. Our investigation is based on a variant of the heterogeneous autoregressive realized volatility model, using daily realized variance and return series from 1996 to 2004. We find that a depreciation against USD leads to significantly greater volatility than an appreciation for AUD and GBP, whereas the opposite is true for JPY. Relative to volatility on days following a positive one-standard-deviation return, volatility on days following a negative one-standard-deviation return is higher by 6.6% for AUD, 6.1% for GBP, and 21.2% for JPY. The realized volatility of EUR appears to be symmetric. These results are robust to the removal of jump component from realized volatility and the sub-samplings defined by structural-changes. The asymmetry in AUD, GBP and JPY appears to be embedded in the continuous component of realized volatility rather than the jump component.     

ESTIMATING EXPECTED EXCESS RETURNS USING HISTORICAL AND OPTION‐IMPLIED VOLATILITY

We test the relation between expected and realized excess returns for the S&P 500 index from January 1994 through December 2003 using the proportional reward‐to‐risk measure to estimate expected returns. When risk is measured by historical volatility, we find no relation between expected and realized excess returns. In contrast, when risk is measured by option‐implied volatility, we find a positive and significant relation between expected and realized excess returns in the 1994–1998 subperiod. In the 1999–2003 subperiod, the option‐implied volatility risk measure yields a positive, but statistically insignificant, risk‐return relation. We attribute this performance difference to the fact that, in the 1994–1998 subperiod, return volatility was lower and the average return was much higher than in the 1999–2003 subperiod, thereby increasing the signal‐to‐noise ratio in the latter subperiod.     

Exchange Rate Exposure at the Firm and Industry Level

Previous work on the exposure of firms to exchange rate risk has primarily focused on U.S. firms and, surprisingly, found stock returns were not significantly affected by exchange‐rate fluctuations. The equity market premium for exposure to currency risk was also found to be insignificant. In this paper we examine the relation between Japanese stock returns and unanticipated exchange‐rate changes for 1,079 firms traded on the Tokyo stock exchange over the 1975–1995 period. Second, we investigate whether exchange‐rate risk is priced in the Japanese equity market using both unconditional and conditional multifactor asset pricing testing procedures. We find a significant relation between contemporaneous stock returns and unanticipated yen fluctuations. The exposure effect on multinationals and high‐exporting firms, however, is found to be greater in comparison to low‐exporting and domestic firms. Lagged‐exchange rate changes on firm value are found to be statistically insignificant implying that investors are able to assess the impact of exchange‐rate changes on firm value with no significant delay. The industry level analysis corroborates the cross‐sectional findings for Japanese firms in that they are sensitive to contemporaneous unexpected exchange‐rate fluctuations. The co‐movement between stock returns and changes in the foreign value of the yen is found to be positively associated with the degree of the firm's foreign economic involvement and inversely related to its size and debt to asset ratio. Asset pricing tests show that currency risk is priced. We find corroborating evidence in support of the view that currency exposure is time varying. Our results indicate that the foreign exchange‐rate risk premium is a significant component of Japanese stock returns. The combined evidence from the currency exposure and asset pricing analyses, suggests that currency risk is priced and, therefoe, has implications for corporate and portfolio managers.     

Volatility transmission in emerging European foreign exchange markets

This paper studies the dynamics of volatility transmission between Central European (CE) currencies and the EUR/USD foreign exchange using model-free estimates of daily exchange rate volatility based on intraday data. We formulate a flexible yet parsimonious parametric model in which the daily realized volatility of a given exchange rate depends both on its own lags as well as on the lagged realized volatilities of the other exchange rates. We find evidence of statistically significant intra-regional volatility spillovers among the CE foreign exchange markets. With the exception of the Czech and, prior to the recent turbulent economic events, Polish currencies, we find no significant spillovers running from the EUR/USD to the CE foreign exchange markets. To measure the overall magnitude and evolution of volatility transmission over time, we construct a dynamic version of the Diebold–Yilmaz volatility spillover index and show that volatility spillovers tend to increase in periods characterized by market uncertainty.     

Central bank interventions and jumps in double long memory models of daily exchange rates

In this paper, we estimate ARFIMA–FIGARCH models for the major exchange rates (against the US dollar) which have been subject to direct central bank interventions in the last decades. We show that the normality assumption is not adequate due to the occurrence of volatility outliers and its rejection is related to these interventions. Consequently, we rely on a normal mixture distribution that allows for endogenously determined jumps in the process governing the exchange rate dynamics. This distribution performs rather well and is found to be important for the estimation of the persistence of volatility shocks. Introducing a time-varying jump probability associated to central bank interventions, we find that the central bank interventions, conducted in either a coordinated or unilateral way, induce a jump in the process and tend to increase exchange rate volatility.     

Asset pricing and foreign exchange risk

According to the International Capital Asset Pricing Model (ICAPM), the covariance of assets with foreign exchange currency returns should be a risk factor that must be priced when the purchasing power parity is violated. The goal of this study is to re-examine the relationship between stock returns and foreign exchange risk. The novelties of this work are: (a) a data set that makes use of daily observations for the measurement of the foreign exchange exposure and volatility of the sample firms and (b) data from a Eurozone country.The methodology we make use in reference to the estimation of the sensitivity of each stock to exchange rate movements is that it allows regressing stock returns against factors controlling for market risk, size, value, momentum, foreign exchange exposure and foreign exchange volatility. Stocks are then classified according to their foreign exchange sensitivity portfolios and the return of a hedge (zero-investment) portfolio is calculated. Next, the abnormal returns of the hedge portfolio are regressed against the return of the factors. Finally, we construct a foreign exchange risk factor in such manner as to obtain a monotonic relation between foreign exchange risk and expected returns.The empirical findings show that the foreign exchange risk is priced in the cross section of the German stock returns over the period 2000-2008. Furthermore, they show that the relationship between returns and foreign exchange sensitivity is nonlinear, but it takes an inverse U-shape and that foreign exchange sensitivity is larger for small size firms and value stocks.     

Intertemporal risk-return trade-off in foreign exchange rates

We investigate the intertemporal risk-return trade-off of foreign exchange (FX) rates for ten currencies quoted against the USD. For each currency, we use three risk measures simultaneously that pertain to that currency; its realized volatility, its realized skewness, and its value-at-risk. We apply monthly FX excess returns and risk measures calculated from daily observations. We find that there is a significant contemporaneous risk-return trade-off for the currencies under investigation. There is no evidence of noncontemporaneous risk-return trade-off. We pay special attention to the risk-return trade-off during the recent financial crisis.     

Portfolio Returns,Market Volatility,and Seasonality

This paper examines three important issues related to the relationship between stock returns and volatility. First, are Duffee's (1995) findings of the relationship between individual stock returns and volatility valid at the portfolio level? Second, is there a seasonality of the market return volatility? Lastly, do size portfolio returns react symmetrically to the market volatility during business cycles? We find that the market volatility exhibits strong autocorrelation and small size portfolio returns exhibit seasonality. However, this phenomenon is not present in large size portfolios. For the entire sample period of 1962–1995, the highest average monthly volatility occurred in October, followed by November, and then January. Examining the two sub-sample periods, we find that the average market volatility increases by 15.4% in the second sample period of 1980–1995 compared to the first sample period of 1962–1979. During the contraction period, the average market volatility is 60.9% higher than that during the expansion period. Using a binary regression model, we find that size portfolio returns react asymmetrically with the market volatility during business cycles. This paper documents a strongly negative contemporaneous relationship between the size portfolio returns and the market volatility that is consistent with the previous findings at the aggregate level, but is inconsistent with the findings at the individual firm level. In contrast with the previous findings, however, we find an ambiguous relationship between the percentage change in the market volatility and the contemporaneous stock portfolio returns. This ambiguity is attributed to strongly negative contemporaneous and one-month ahead relationships between the market volatility and portfolio returns.

     

Economic fundamentals and the long-run correlation between exchange rates and commodities

We examine the short-run and long-run dynamics of the correlation between exchange rate and commodity returns, and assess the extent to which the long-run correlation is determined by economic fundamentals. Our empirical analysis is based on the dynamic conditional correlation model with mixed-data sampling (DCC-MIDAS). This model separates the high-frequency from the low-frequency dynamics of volatility and correlation and allows us to relate long-run volatility and correlation to economic fundamentals. Using both economic and statistical criteria for performance evaluation, we find that economic fundamentals are important determinants of the long-run correlation between exchange rate and commodity returns.