Interpreting Currency Movements During the Crisis: What's the Role of Interest Rate Differentials?
45 Pages Posted: 1 Feb 2011
Date Written: Janurary 2011
Using an adaptation of the Uncovered Interest Parity (UIP) condition, this paper analyzes the drivers behind the large, symmetric exchange rate swings observed during the financial crisis of 2008-2010. Employing a Nelson-Siegel model, we estimate yield curves and decompose the exchange rate movements into changes we attribute to monetary policy and a residual. We find that the depreciation phase of the currencies in our sample was largely dominated by safe-haven effects rather than carry trade activity or other return considerations. For some countries, however, the appreciation that began at the end of 2008 seems largely to reflect downward movement in the cumulative revisions to nominal forward differentials, suggesting carry trade.
Keywords: Currencies, Developed countries, Economic models, Emerging markets, Exchange rate adjustments, Exchange rates, Financial crisis, Global Financial Crisis 2008-2009, Interest rates, Monetary policy
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