RESPONSE OF FINANCIAL MARKETS TO ANNOUNCEMENTS OF THE AUSTRALIAN CURRENT ACCOUNT BALANCE

This paper documents the response of exchange rates, interest rates and stock prices to monthly announcements of the Australian current account balance. Survey data on market participants' expectations and forecasts generated from ARIMA time series models are used to identify the unexpected component of the announcements. The study also controls for day-of-the-week effects that have been documented in the Australian equity market The results support the efficient market hypothesis and show a significant depreciation of the Australian dollar in foreign exchange markets and a significant rise in both short- and long-term interest rates to announcements of larger than expected current account deficits. The study was, however, unable to find evidence of a significant stock price response to the current account announcements.     

Macroeconomic news and exchange rates

This paper examines the relationship between macroeconomic news and the dollar–Mark and dollar–Yen exchange rates. We employ high-frequency observations for a 10-year period. We investigate whether exchange rate observations need to be sampled at a high frequency in order to detect significant effects from news announcements on mean returns and volatility. We examine the linearity and symmetry of the responses to news and also allow the effects of the news announcements to vary across states of the economy. We find that news indicating a stronger U.S. economy causes an appreciation of the U.S. dollar, that the responses are essentially complete within 5 min, and that measuring the responses over 6-h intervals eliminates the statistical significance of the news. The effects of news appear linear and symmetric but there is some evidence that the effects depend on the state of the economy.     

Are US-Dollar-Hedged-ETF investors aggressive on exchange rates? A panel VAR approach

Exchange traded funds (ETFs) are a multi-trillion dollar market that epitomizes financialization due to its recent growth. This study examines the behavior of U.S. listed currency hedged ETF investors towards changes in the underlying benchmark and foreign exchange rate from July 2011 to November 2015 using a panel VAR approach. We find that investors are able to anticipate changes in future exchange rates and invest in currency hedged ETFs prior to changes. Granger-causality tests confirm that these investors proactively trade before large real exchange rate movements. These results suggest that the use of financial instruments such as ETFs to hedge against exchange rate volatility may have itself become a source of volatility, which have implications for the further financialization of the ETF industry.     

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.     

The high-frequency impact of news on long-term yields and forward rates: Is it real?

Macroeconomic news announcements move yields and forward rates on nominal and index-linked bonds and inflation compensation. This paper estimates the reactions using high-frequency data on nominal and index-linked bond yields, allowing the effects of news announcements on real rates and inflation compensation to be parsed far more precisely than is possible using daily data. Long-term nominal yields and forward rates are very sensitive to macroeconomic news announcements. Inflation compensation is sensitive to announcements about price indices and monetary policy. However, for news announcements about real economic activity, such as nonfarm payrolls, the vast majority of the sensitivity is concentrated in real rates. Accordingly, most of the sizeable impact of news about real economic activity on the nominal term structure of interest rates represents changes in expected future real short-term interest rates and/or real risk premia rather than changes in expected future inflation and/or inflation risk premia. Such sensitivity of real rates to macroeconomics news is hard to rationalize within the framework of existing macroeconomic models.     

The impact of exchange rate deviations from relative PPP equilibrium on the U.S. demand for foreign equities

Applying fixed-effects panel data, this study investigates the impact of U.S. dollar exchange rate movements during different exchange rate states (overvaluation and undervaluation) on the monthly real gross and real net purchases of foreign equities by U.S. residents over the post-Plaza Accord period. The foreign equities come from 22 developed and 25 developing countries. Previous research has posited two alternative hypotheses regarding the relationship between exchange rates and foreign investment. These are the wealth effect and the profit-oriented effect. The evidence herein suggests that these two hypotheses coexist. We find robust evidence for a negative relationship between the exchange rate movements of an undervalued U.S. dollar and the demand for foreign equities. For developed countries, the wealth effect dominates the profit-oriented effect when the U.S. dollar is overvalued, while, for developing countries, the profit-oriented effect dominates the wealth effect. The results emphasize the importance of considering exchange rate states derived from a relative PPP equilibrium when analyzing U.S. allocations to foreign equities. The findings with respect to the macroeconomic control variables are mainly in agreement with the predictions of international financial theory. Some of the results, however, disappear or become inconclusive for the period after the bankruptcy of Lehman Brothers. This may be explained by the increased uncertainty in international financial markets following this unprecedented event. The findings are robust with respect to different constructed equilibrium exchange rates.     

Tests of the hypothesis of the existence of risk premium in the foreign exchange market

This paper tests for a risk premium in the foreign exchange market. The null hypothesis of the test is the random walk hypothesis in the foreign exchange market. The alternative hypothesis is that biases of current spot rates (or forward rates) from future spot rates are systematically related to a set of economic variables on which a risk premium may depend. This paper provides firm evidence for a risk premium in the foreign exchange market. The risk premium explains 10–20% of the total variance in future spot rates when the US dollar/mark quarterly rates are used. The magnitudes are smaller (less than 10%) for monthly rates.     

Forecasting foreign exchange rates using idiosyncratic volatility

Average idiosyncratic stock volatility forecasts the bilateral exchange rates of the US dollar against major foreign currencies in and out of sample. The US dollar tends to appreciate after an increase in US idiosyncratic volatility. Similarly, ceteris paribus, German and Japanese idiosyncratic volatilities positively and significantly correlate with future US dollar prices of the Deutsche mark and the Japanese yen, respectively. Our results suggest that exchange rates are predictable.     

Forecasting exchange rates under parameter and model uncertainty

We introduce a forecasting method that closely matches the econometric properties required by exchange rate theory. Our approach formally models (i) when (and if) predictor variables enter or leave a regression model, (ii) the degree of parameter instability, (iii) the (potentially) rapidly changing relevance of regressors, and (iv) the appropriate shrinkage intensity over time. We consider (short-term) forecasting of six major US dollar exchange rates using a standard set of macro fundamentals. Our results indicate the importance of shrinkage and flexible model selection/averaging criteria to avoid poor forecasting results.     

Global asset prices and FOMC announcements

This paper analyzes the impact of U.S. monetary policy announcement surprises on foreign equity indexes, short- and long-term interest rates, and exchange rates in 49 countries. We use two proxies for monetary policy surprises: the surprise change to the current target federal funds rate (target surprise) and the revision to the expected path of future monetary policy (path surprise). We find that different asset classes respond to different components of the monetary policy surprises. Global equity indexes respond mainly to the target surprise; exchange rates and long-term interest rates respond mainly to the path surprise; and short-term interest rates respond to both surprises. On average, a hypothetical surprise 25-basis-point cut in the federal funds target rate is associated with about a 1 percent increase in foreign equity indexes and a 5 basis point decline in foreign short-term interest rates. A surprise 25-basis-point downward revision in the expected path of future policy is associated with about a ½ percent decline in the exchange value of the dollar against foreign currencies and 5 and 8 basis point declines in short- and long-term interest rates, respectively. We also find that asset prices’ responses to FOMC announcements vary greatly across countries, and that these cross-country variations in the response are related to a country’s exchange rate regime. Equity indexes and interest rates in countries with a less flexible exchange rate regime respond more to U.S. monetary policy surprises. In addition, the cross-country variation in the equity market response is strongly related to the percentage of each country’s equity market capitalization owned by U.S. investors. This result suggests that investors’ asset holdings may play a role in transmitting monetary policy surprises across countries.     

Timing exchange rates using order flow: The case of the Loonie

This paper examines the relation between the Canadian dollar/US dollar (CAD) exchange rate and foreign exchange order flow employing a novel data set on CAD order flow over the period 1994–2005. We investigate empirically the predictive information content and the determinants of order flow. The results suggest that order flow has strong out-of-sample predictive power for CAD returns, yielding significant market timing ability and tangible economic gains in a stylized dynamic asset allocation context. In terms of its determinants, order flow appears to reflect not only the menu of macroeconomic variables typically suggested in the literature but is also closely related to commodity price fluctuations, as expected from a ‘commodity currency’.     

Forward and spot exchange rates in a bivariate TAR framework

Structural exchange rate models explain only a small part of the movements in dollar exchange rate. Recent empirical work has focused on the failure to account for nonlinearities in the data generating mechanism, as an explanation of this bad performance. Here two bivariate threshold autoregressive models for the spot and forward exchange rates are considered. In the first model the regimes are determined by the log difference of the two rates; in the second one the regimes are driven by the forward spot no-arbitrage condition. These processes are able to capture the ‘swing’ behaviour observed in the exchange rate market. Finally the forecasting ability of the models for the dollar/DM exchange rate is evaluated by stochastic simulation.     

Nonlinear dynamics in foreign exchange rates

This paper investigates whether the behavior of real and nominal foreign exchange rates as well as interest rates are governed by nonlinear dynamics; it also explores whether observed deviations from parity conditions exhibit nonlinear dependence. Standard statistical tests for randomness, such as autocorrelation tests, have low power against a large class of deterministic, nonlinear processes. Discerning nonrandomness of innovations in exchange rates is important for a variety of reasons. For example, many models of international asset pricing assume exchange rates to follow a random walk. Furthermore, nonlinear patterns in deviations from various exchange rate parities have implications for the existence of a time-varying foreign exchange risk premium. With the use of the BDS statistic and a correlation dimension analysis, this paper's primary findings are that (1) foreign exchange markets have become increasingly complex and therefore less amenable to forecasting over time; (2) although forward exchange risk premia are statistically significant and display a deterministic structure, this structure is complex and therefore not easily discernible; and (3) innovations in real exchange rates are consistent with a Purchasing Power Parity equilibrium.     

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.     

Discount rate changes and the foreign exchange market

Changes in the discount rate can have associated announcement effects on the foreign exchange value of the dollar only if these changes are not anticipated by the market. This paper provides evidence to support this contention. Specifically, discount rate changes made for reasons other than technical adjustments have not been anticipated fully and, consequently, their announcements have had a significant impact on the dollar's exchange rate. Furthermore, results are obtained that support the hypothesis that unanticipated discount rate changes alter inflationary expectations.     

Emerging market exchange rates during quantitative tapering: The effect of US and domestic news

We analyze the impact of domestic and US-based news announcements of a large set of economic and policy-related fundamentals on the US dollar versus the Turkish lira exchange rate from 2013 to 2016. Since exchange rate behavior is closely related to political trust, we also incorporate the effect of domestic and global political uncertainty, using country indices based on Google search results. Contrary to previous findings, our results reveal that surprises related to the domestic economy have a greater effect on the exchange rate compared to surprises related to the US economy. Most important are the surprises related to domestic inflation and monetary policy, as well as foreign employment, while political uncertainty plays a minor role. There is also an asymmetry in the market response. Bad news about the US economy has more impact than good news, and good news about the domestic economy has more impact than bad news.     

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.     

U.S. presidential cycles and the foreign exchange market

We examine the association between the foreign exchange rate of the US dollar and US presidential cycles. Results show that Republican presidencies tend to start with a strong dollar, which then depreciates over the course of the presidency. In contrast, Democratic presidencies tend to begin with a weak dollar that then appreciates. These patterns result in an apparent presidential effect in US foreign exchange rates, the direction of which depends on whether exchange rates are measured by levels or by returns.     

International interest rates and US monetary policy announcements: Evidence from Hong Kong and Singapore

This paper investigates the responses of market interest rates to US monetary policy announcements for the US and two emerging economies, Hong Kong and Singapore which are similar on many respects but have experienced opposite exchange rate regimes in the last twenty years. Our results, based on market expectations extracted from federal fund futures rates, document that FOMC announcements significantly affect the term structure of interest rate in the US and both Asian countries. Further, international interest rate differentials around FOMC meeting dates tend to be negative for short maturities with the impact gradually dissipating as bond maturity increases. Finally, for the case of Singapore, we find that domestic interest rates react to both external and domestic monetary policy announcements with a magnitude that is larger over the full bond maturity spectrum for domestic announcements. These results are robust to time-varying futures risk premia and alternative measures of interest rates expectations.     

Bandwagon effects and run patterns in exchange rates

I analyze the monthly exchange rates of the US dollar against the pound sterling, the Japanese yen, and the Swiss franc. All three exchange rates show bandwagon patterns, changes in one direction tend to be followed by changes in the same direction. This regularity points towards the importance of momentum traders on foreign exchange markets. A recent experimental analysis suggests the following hypothesis regarding the dynamics of bandwagon effects: if there is a repetition of similar occurrences many agents expect this run to continue but reduce the perceived chances of further repetitions when they actually occur. For exchange rates this implies that a continuation of a change in one direction should become weaker if an exchange rate has shown repeated changes in the same direction in the immediate past. This conjecture is supported by the findings of this study.