The Response of Exchange Rate to Central Bank Communication: A Textual Analysis Approach
55 Pages Posted: 25 Jun 2019
Date Written: May 19, 2019
The study explores how central bank communication affects the exchange rate. The paper constructs sentiment by employing textual information from the European Central Bank press conferences. Using high frequency data, we find that a more positive/negative sentiment is associated with appreciation/depreciation of euro, and de- creasing/increasing exchange rate volatility. We apply Latent Dirichlet Allocation ap- proach to decompose central bank communication into a variety of topics. The results indicate that EUR-USD responds most strongly to topics of economic growth, mone- tary policy stance central bank liquidity provision, lending activities, and risk outlook) while the response of the exchange rate mutes with historical or current economic discussion (e.g. monetary policy decision, monetary policy assessment).
Keywords: Central bank communication, exchange rate, sentiment, LDA, textual analysis
JEL Classification: G11, G12, E52, E58
Suggested Citation: Suggested Citation