Exchange Rate Market Expectations and Central Bank Policy: The Case of the Mexican Peso-US Dollar from 2005-2009

37 Pages Posted: 10 Mar 2011 Last revised: 2 Jul 2019

See all articles by Gustavo Abarca

Gustavo Abarca

Bank of Mexico

Guillermo Benavides

Banco de Mexico; Universidad del Valle de Mexico

Jose Gonzalo Rangel

Goldman Sachs Group, Inc. - Global Investment Research

Date Written: March 9, 2011

Abstract

This paper examines two approaches characterized by different tail features to extract market expectations on the Mexican peso-US dollar exchange rate. Expectations are gauged by Risk-Neutral Densities (RNDs). The methods used to estimate these densities are the Volatility Function Technique (VFT) proposed by Malz (1997) and the Generalized Extreme Value (GEV) approach suggested by Figlewski (2009). We compare these methods in the context of monetary policy announcements in Mexico and the US. We find evidence that US surprises, which are measured following Kuttner (2001), have significant effects on exchange rate variations. Around event days in Mexico and the US, the results also indicate that, although both VFT and GEV suggest similar dynamics at the center of the distribution, these two methods show significantly different patterns in the tails. Our empirical evidence shows that the GEV captures better the extreme values of the distribution around monetary policy event days given its unique procedure that allows for longer asymptotically well-behaved tails. This explains the main differences.

Keywords: Exchange Rates, Interest Rate Targeting, Market Expectations, Mexican Peso-U.S. Dollar Exchange Rate, Monetary Policy, Risk-Neutral Densities

JEL Classification: C14, E44, E58, F31

Suggested Citation

Abarca, Gustavo and Benavides, Guillermo and Rangel, Jose Gonzalo, Exchange Rate Market Expectations and Central Bank Policy: The Case of the Mexican Peso-US Dollar from 2005-2009 (March 9, 2011). Journal of Derivatives, Vol. 19, No. 4, 2012. Available at SSRN: https://ssrn.com/abstract=1782312 or http://dx.doi.org/10.2139/ssrn.1782312

Gustavo Abarca

Bank of Mexico ( email )

Av. 5 de Mayo 18
Piso 4
Mexico City, 06059
Mexico

Guillermo Benavides (Contact Author)

Banco de Mexico ( email )

Cinco de Mayo # 2
Mexico DF, 06059
Mexico

Universidad del Valle de Mexico ( email )

Calzada de Tlalpan No. 3058. Santa Ursula Coapa
Distrito Federal, 29000
Mexico

HOME PAGE: http://ssrn.com/author=386155

Jose Gonzalo Rangel

Goldman Sachs Group, Inc. - Global Investment Research ( email )

200 West Street
New York, NY 10280
United States

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