Central Bank Information Shocks and Exchange Rates

44 Pages Posted: 20 Apr 2020

Date Written: April 20, 2020

Abstract

The dynamic effects of ECB announcements, disentangled into pure monetary policy and central bank information shocks, on the euro (EUR) exchange rate are examined using a Bayesian Proxy Vector Autoregressive (VAR) model fed with high-frequency data. Contractionary monetary policy shocks result in a sizable appreciation of the nominal effective and bilateral EUR exchange rates, peaking on impact. By contrast, despite similar effects on interest rate differentials, responses to central bank information shocks exhibit strong heterogeneities across currency pairs. This disparity can be rationalized by an increase in investors' risk appetite, as measured by the VIX, triggering capital flows into speculative currencies when the ECB reveals a surprisingly sanguine economic outlook. In line with this, the EUR depreciates against a high-yielding carry trade investment portfolio, while it appreciates against a low-yielding carry trade funding portfolio.

Keywords: central bank information, monetary policy, exchange rate, Proxy VAR, high-frequency data, carry trades

JEL Classification: E52, E58, F31

Suggested Citation

Franz, Thorsten, Central Bank Information Shocks and Exchange Rates (April 20, 2020). Deutsche Bundesbank Discussion Paper No. 13/2020, Available at SSRN: https://ssrn.com/abstract=3581184

Thorsten Franz (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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