Economic news,exchange rates and interest rates

The paper examines the post-October 1979 response of exchange rates and interest rates to the new information contained in the first announcement of fifteen US macroeconomic series. Markets respond primarily to monetary news, but also to news about the trade deficit, domestic inflation, and variables that reflect the state of the business cycle. For all fifteen macroeconomic variables, an increase (decrease) in interest rates is accompanied by an appreciation (depreciation) of the dollar, which is consistent with models that stress price rigidity and absence of purchasing power parity.     

Spot rates,forward rates and exchange market efficiency

This paper examines the relationship between forward exchange rates and subsequently observed spot rates. No evidence is found for a liquidity premium on forward exchange, indicating that the forward rate can be used as a proxy of the market's expectations and that open exchange positions involve little systematic risk. It is also shown that forward exhange is priced as if the exchange rate could be characterized by a diffusion process with a trend, although there is some evidence such a process does not adequately characterize the exchange rate in all cases.     

Uncertain inflation,exchange rates,and bond yields

The yields on international bonds are affected by exchange rate risk and country risk, in addition to factors such as default and duration that are relevant in the pricing of domestic bonds. This paper constructs a theory of bond yields in a single period framework, with the risk of nominal bonds being endogenous to the model. The behaviour of the monetary authority is modelled explicitly and is shown to be a crucial determinant of the risk of nominal bonds. A distinction is made between the risk of default in the usual sense, and the risk of being paid in currency which is worth less in real terms, with the type of risk that is relevant in a particular case depending on the monetary policy followed. The implications of results for exchange rate risk are also explored in a world where Purchasing Power Parity holds.     

Nontraded goods, market segmentation, and exchange rates

Empirical evidence suggests that movements in international relative prices are large and persistent. Nontraded goods, both in the form of final consumption goods and as an input into the production of final tradable goods, are an important aspect driving international relative price movements. In this paper we show that nontraded goods play an important role in the context of an otherwise standard open-economy macromodel. Our quantitative study with nontraded goods generates implications along several dimensions that are more closely in line with the data relative to the model that abstracts from nontraded goods.     

Risk appetite,carry trade and exchange rates

Using exchange rate data from four different countries (time zones), we examine the relationship between the Yen exchange rate against major currencies (i.e. USD/JPY, EUR/JPY, GBP/JPY, AUD/JPY and NZD/JPY) and measures of risk appetite (i.e. the S&P500 index, Dow Jones Industrial Average index and the VIX index). Our results show that the equity indexes, especially the Dow Jones Industrial Average, play a more important role in the determination of the Yen cross rates than VIX. The popular carry-trade currencies, i.e. NZD/JPY, AUD/JPY and GBP/JPY, are more affected by the US equity market than USD/JPY and EUR/JPY. While the long-term relationships are consistent across the four different time zones, the short-term dynamics are different. We find that the response of NZD/JPY, AUD/JPY and GBP/JPY to changes in the US stock market is much greater in the New Zealand and Australian zones than in the UK or US. Although the short-term relationship between exchange rates and the equity index is quite strong, the error correction speed is very sluggish. We also find evidence of asymmetric adjustment in the response of exchange rates to changes in global risk aversion. Carry trade currencies tend to appreciate gradually when conditions are favorable but fall sharply when market risk increases.     

Floating exchange rates,expectations and new information

This paper analyzes the relationship between forward exchange rates, future spot rates and new information. A stochastic model of exchange rate determination is used to formally show how unanticipated changes in the exchange rate determinants (or ‘news’) affect the spot rate. The empirical analysis indicates that ‘new information’ plays an important role in explaining the market forecasting error, or difference between the spot rate and the forward rate, determined in the previous period.     

Foreign exchange intervention and equilibrium real exchange rates

Monetary authorities intervene in the currency markets in order to pursue a monetary rule and/or to smooth exchange rate volatility caused by speculative attacks. In the present paper we investigate for possible intervention effects on the volatility of nominal exchange rates and the estimated equilibrium behaviour of real exchange rates. The main argument of the paper is that omission of intervention effects – when they are significant – would bias the ability to detect any PPP-based behaviour of the real exchange rates in the long run. Positive evidence for this argument comes from the experience of six Central and Eastern European economies, whose exchange markets are characterised by frequent interventions.     

Forward and spot exchange rates

There is a general consensus that forward exchange rates have little if any power as forecasts of future spot exchange rates. There is less agreement on whether forward rates contain time varying premiums. Conditional on the hypothesis that the forward market is efficient or rational, this paper finds that both components of forward rates vary through time. Moreover, most of the variation in forward rates is variation in premium, and the premium and expected future spot rate components of forward rates are negatively correlated.     

Rational speculation and exchange rates

Models of exchange rates have typically failed to produce results consistent with the key fact that real and nominal exchange rates move in ways not closely connected to current (or past) macroeconomic variables. Models that rely on the same shocks to drive fluctuations in macroeconomic variables and exchange rates typically imply counterfactually-strong co-movements between them. We develop a model in which new information leads agents to change their rational beliefs about risk premia on foreign exchange markets. These changes in risk premia work through asset markets to cause real and nominal exchange rates to change without corresponding changes in GDP, productivity, money supplies, and other key macro variables.     

Interest rates and exchange rates: Some new empirical results

This paper presents indirect evidence on the behavior on the real interest rate by studying the correlations between changes in nominal interest rates and in exchange rates. These correlations are examined both before and after October 6, 1979. The empirical evidence supports the views that monetary shocks affect the real rate and that the change in Fed monetary policy on October 6 led to greater variation in the real rate.     

Monetary shocks,exchange rates,and the extensive margin of exports

This paper develops a two-country Dynamic General Equilibrium model to assess the relationship between the real exchange rate and the extensive margin of exports. Exchange rate pass-through to consumer prices governs the relative strength of a demand channel onto the exporting decision of a firm. With incomplete pass-through, a favorable movement in the real exchange rate generates increased export participation and an expansion in the extensive margin of exports. This result is consistent with firm-level studies, and contributes to an ongoing empirical debate as to the importance of changes in export participation over the business cycle.     

Regime-switching models for exchange rates

This study provides evidence of periodically collapsing bubbles in the British pound to US dollar exchange rate in the post-1973 period. We develop two- and three-state regime-switching (RS) models that relate the expected exchange rate return to the bubble size and to an additional explanatory variable. Specifically, we consider six alternative explanatory variables that have been proposed in the literature as early warning indicators of a currency crisis. Our findings suggest that the RS models are, in general, more accurate than the Random Walk model in terms of both statistical and especially economic evaluation criteria for exchange rate forecasts. Our three-state RS model outperforms the two-state models and among the variables considered in our analysis, the short-term interest rate is the optimal variable, closely followed by imports. Results are more promising for one-month predictions and are qualitatively robust over sample spans. However, various robustness checks based on other exchange rates show that the optimal bubble measures and optimal predictors critically depend on the exchange rate.     

Semi-parametric real exchange rates dynamics

Review of Quantitative Finance and Accounting - A flexible semi-parametric augmented Dickey Fuller (ADF) regression is proposed to explore real exchange rate dynamics for 16 countries over the...     

Real exchange rates and time-varying trade costs

This paper re-examines the empirical modeling of Purchasing Power Parity (PPP) deviations in the presence of commodity market frictions. First, we show that a specific type of smooth transition models can closely approximate the functional form of the theoretical adjustment mechanism derived by Dumas (1992) [Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World, Review of Financial Studies,5:2153-180] for the case of constant as well as changing trade costs. Second, we develop, for the first time, an empirical model of the real exchange rate which allows for changes in the degree of market integration. By employing a long span of data on the Dollar-Sterling real exchange rate and a micro-founded proxy for trade frictions, we provide novel evidence of a significant relationship between the persistence of the real exchange rate and the level of trade costs. This finding suggests that both the difficulty of detecting PPP and the extend of Rogoff’s puzzle vary over time with the degree of trade restrictiveness. Finally, we highlight policy repercussions of our results.     

Clustering and psychological barriers in exchange rates

Contemporary press frequently attaches significance with specific numerical values in exchange rates. This research empirically tests for the presence of clustering and “psychological barriers” (transgressional effects) on various exchange rates involving the Australian dollar. Overall, we find a widespread clustering effect, which accordingly means there is partial information content in the actual numbers of the exchange rates themselves. Furthermore, there is some, but not strong, evidence that perceived “psychological barriers” do exist. Surprisingly, the location and form of both the clustering and transgressional effects and hence the information content differ across different exchange rates and in most instances, they are not in the expected direction.     

Forward exchange rates as predictors of future spot rates and the efficiency of the foreign exchange market

The theory of informationally efficient markets (EMIT) is applied to the foreign exchange market and some of its operational implications are illustrated. The EMIT is joined with alternative models of the equilibrium return on the foreign exchange market: the Pure Expectations Hypothesis, the Modern Theory and tentative formulations of return as a function of risk. The alternative joint Hypotheses are rejected by the data but this does not necessarily imply the rejection of EMIT. The rejection may be due to the inadequacies of the equilibrium return models used, notwithstanding the fact that the risk premium has been captured, to a certain extent, in the empirical tests and the evidence against the EMIT weakened.     

Further on nonlinearity,persistence, and integration properties of real exchange rates

Integration, nonlinearity, and persistence dynamics of several quarterly US-Dollar-denominated real exchange rates are investigated by using new unit root tests, simulated p-values for linearity tests, estimation of smooth transition autoregressive (STAR) models, and simulation of autocorrelation functions. This paper uses a simulation-based approach to study covariance stationarity and persistence dynamics of the estimated models. Findings in the paper provide evidence of nonlinear mean reversion for several series albeit with some persistence. Results also reveal considerable variation in the degree of persistence and timing of switches across extreme regimes in ESTAR models between Euro and non-Euro area currencies.     

Beyond the purchasing power parity: testing for cointegration and causality between exchange rates, prices, and interest rates

This paper reexamines the causality between the dollar and the yen in a multivariate framework with the aid of cointegration and error-correcting modeling for the 1951–94 period. The Phillips-Perron tests and Johansen's tests are performed. While causality from interest rates to exchange rates is found in the short run, no causality between prices and exchange rates is found in the short run. However, causality is found running from relative prices to exchange rates along with interest rates between the U.S. and Japan in the long run, which supports the long-run PPP hypothesis.     

The high-frequency response of exchange rates and interest rates to macroeconomic announcements

The joint movements of exchange rates and U.S. and foreign term structures over short-time windows around macro announcements are studied using a 14-year span of high-frequency data. In order to evaluate whether the joint effects can be reconciled with conventional theory, the implications of these joint movements for changes in expected future exchange rates and changes in foreign exchange risk premia are deduced. For several real macro announcements, a stronger than expected release appreciates the dollar today, and must either (i) lower the risk premium for holding foreign currency rather than dollars, or (ii) imply net expected dollar depreciation over the ensuing decade.