The uncovered interest parity puzzle concerns the empirical regularity that high interest rate countries tend to have high expected returns on short term deposits. A separate puzzle is that high real ...interest rate countries tend to have currencies that are stronger than can be accounted for by the path of expected real interest differentials under uncovered interest parity. These two findings have apparently contradictory implications for the relationship of the foreign-exchange risk premium and interest-rate differentials. We document these puzzles, and show that existing models appear unable to account for both. A model that might reconcile the findings is discussed.
This study tests both the in-sample and out-of-sample predictive value of oil tail risk for the tail risk of US Dollar exchange rates (USD/CAD, USD/GBP and USD/JPY), where the conditional ...autoregressive value at risk (CAViaR) of the Engle and Manganelli (2004) is used to estimate the tail risks under 1% and 5% VaRs. Thereafter, we construct a predictive model using the best fit tail risks while the predictive value of the oil tail risk is evaluated for both the in-sample and out-of-sample forecasts. We find evidence of a positive association between the oil tail risk and the USD tail risks when the USD/CAD, USD/GBP are considered, where downtowns in the oil markets are capable of causing instabilities in the U.S. foreign exchange market while it is negative for USD/JPY albeit at 5% VaR, suggesting the safe haven property of the latter during oil crisis. Accounting for the dynamics of oil tail risk in the predictive model of the tail risks of USD exchange rates improves both the in-sample and out-of-sample forecasts and the outcome leading to these conclusions is insensitive to the choice of oil price proxy and the magnitude of VaR.
•The predictive value of oil tail risk for the tail risk of US Dollar exchange rates is evaluated.•The conditional autoregressive value at risk (CAViaR) is used to estimate the tail risks under 1% and 5% VaRs.•The analysis is conducted for USD/CAD, USD/GBP and USD/JPY for both the in-sample and out-of-sample forecasts.•The relationship is positive for USD/CAD, USD/GBP while it is negative for USD/JPY albeit at 5% VaR.•Oil market risk causes instabilities in USD/CAD and USD/GBP while USD/JPY can be used to hedge against such instabilities.
We estimate the effect of sovereign credit rating events on the foreign exchange market. Using entropy balancing—a treatment effect methodology that properly addresses the possible self‐selection and ...endogeneity biases related to rating events—we find robust evidence that a positive (negative) sovereign credit rating event significantly increases (decreases) on average exchange rates, with a larger magnitude for negative events. This effect remains significant under flexible (but not under fixed) exchange rate regimes, and displays asymmetries related to the size of the rating event: in particular, only negative large (i.e., above one notch) rating events trigger a significant response of exchange rates. Lastly, we unveil important nonlinearities related to the initial value of the rating, suggesting a possible amplification mechanism: the impact of positive (negative) rating events is stronger in absolute value if ratings are initially high (low).
Based on the wavelet decomposition approach, we study co-movement among foreign exchange markets using the returns of exchange rates (GBP/USD, EUR/USD, and JPY/USD). We focus on the interdependence ...among returns of exchange rates during the recent global financial crisis and European debt crisis. We use a wavelet analysis because of its ability to decompose signals into high and low frequencies. This approach allows us to study shorter time periods independently of longer time periods. The results reveal strong interdependence between the euro and pound sterling at all frequency bands of scale over the sample period. With regard to the yen–pound pairwise, covariation is localized at high scales. Further, we find that interdependence is more pronounced during crises.
•The contagion and interdependence of foreign exchange markets are investigated.•Wavelet coherence is used for empirical analysis.•Financial contagion spreads through the foreign exchange markets during crises.•We find a high degree of integration in the European foreign exchange markets.•The contagion effect between the pound and yen seems modest.
ABSTRACT
The U.S. dollar appreciates in the run‐up to foreign exchange (FX) fixes and depreciates thereafter, tracing a W‐shaped return pattern around the clock. Return reversals for the top nine ...traded currencies over a 21‐year period are pervasive and highly statistically significant, and they imply daily swings of more than one billion U.S. dollars based on spot volumes. Using natural experiments, we document the existence of a published reference rate determines the timing of intraday return reversals. We present evidence consistent with an inventory risk explanation whereby FX dealers intermediate unconditional demand for U.S. dollars at the fixes.
Common Risk Factors in Currency Markets Lustig, Hanno; Roussanov, Nikolai; Verdelhan, Adrien
The Review of financial studies,
11/2011, Letnik:
24, Številka:
11
Journal Article
Recenzirano
Odprti dostop
We identify a "slope" factor in exchange rates. High interest rate currencies load more on this slope factor than low interest rate currencies. This factor accounts for most of the cross-sectional ...variation in average excess returns between high and low interest rate currencies. A standard, no-arbitrage model of interest rates with two factors—a country-specific factor and a global factor—can replicate these findings, provided there is sufficient heterogeneity in exposure to global or common innovations. We show that our slope factor identifies these common shocks, and we provide empirical evidence that it is related to changes in global equity market volatility. By investing in high interest rate currencies and borrowing in low interest rate currencies, U.S. investors load up on global risk.
The Bank of Papua New Guinea has maintained an active policy of foreign exchange (FX) market intervention. This monetary tool is associated with a depreciating currency and a worsening shortage of ...foreign currencies in the domestic market, suggesting that at most the policy instrument leans against existing FX‐market pressure. However, the one‐sided sales of central bank securities (or bills) engender an appreciation of the rate and an easing of the shortage in the domestic FX market. Supported by empirical evidence, we demonstrate that the one‐sided sales of central bank bills perform like an instrument of monetary policy for FX‐market stability in the presence of persistent nonremunerated excess bank reserves.
Exchange Rate Predictability Rossi, Barbara
Journal of economic literature,
12/2013, Letnik:
51, Številka:
4
Journal Article
Recenzirano
Odprti dostop
The main goal of this article is to provide an answer to the question: does anything forecast exchange rates, and if so, which variables? It is well known that exchange rate fluctuations are very ...difficult to predict using economic models, and that a random walk forecasts exchange rates better than any economic model (the Meese and Rogoff puzzle). However, the recent literature has identified a series of fundamentals/methodologies that claim to have resolved the puzzle. This article provides a critical review of the recent literature on exchange rate forecasting and illustrates the new methodologies and fundamentals that have been recently proposed in an up-to-date, thorough empirical analysis. Overall, our analysis of the literature and the data suggests that the answer to the question: "Are exchange rates predictable?" is, "It depends"—on the choice of predictor, forecast horizon, sample period, model, and forecast evaluation method. Predictability is most apparent when one or more of the following hold: the predictors are Taylor rule or net foreign assets, the model is linear, and a small number of parameters are estimated. The toughest benchmark is the random walk without drift.
We propose and estimate a quantitative model of exchange rates in which participants in the foreign exchange market are intermediaries subject to value-at-risk (VaR) constraints. Higher volatility ...translates into tighter VaR constraints, and intermediaries require higher returns to hold foreign assets. Therefore, the foreign currency is expected to appreciate. The model quantitatively resolves the Backus–Smith puzzle, the forward premium puzzle, and the exchange rate volatility puzzle and explains deviations from the covered interest rate parity. Moreover, the model implies both contemporaneous and predictive relations between proxies of leverage constraint tightness and exchange rates. These implications are supported in the data.
There is a significant difference between de facto and de jure regimes in terms of exchange rates, especially in emerging market economies. A simple open economy model is used to test the empirical ...plausibility of a managed exchange rate system in which the monetary authority responds to exchange rate movements with foreign exchange intervention as an additional goal of monetary policy. This study demonstrates that this system fits the data better than a float-system specification. In addition, it is found that the authorities in Asian countries are more likely to intervene in the foreign exchange market with a higher degree of concern regarding exchange rate movements. The study empirically confirms that all emerging market inflation targeters have employed a de facto managed exchange rate system while adopting a de jure float system.
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