U.S. Dollar Dynamics: How Important Are Policy Divergence and FX Risk Premiums?
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Summary:
We investigate the drivers of dynamics of major U.S. FX bilaterals. We first construct a novel measure of FX risk premiums using Consensus exchange rate forecasts. We then use VAR analysis to show that (i) risk premium shocks play a key role in driving dynamics of the major U.S. FX bilaterals; (ii) longer-term interest differentials also matter, especially for the Canadian $ and the Euro; (iii) oil price shocks play a particularly important role for the Canadian $ (an oil exporter); and (iv) risk appetite shocks (e.g., VIX shocks) generally lead to U.S. dollar appreciation. The importance of risk premium and longer-term interest differential shocks fit well with a simple theoretical model and are supported by recent event studies.
Series:
Working Paper No. 2016/125
Subject:
Exchange rate adjustments Exchange rate risk Exchange rates Financial regulation and supervision Foreign exchange National accounts Return on investment
English
Publication Date:
July 5, 2016
ISBN/ISSN:
9781498348416/1018-5941
Stock No:
WPIEA2016125
Pages:
47
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