A Fundamental Connection: Exchange Rates and Macroeconomic Expectations

59 Pages Posted: 15 Jul 2021

See all articles by Vania Stavrakeva

Vania Stavrakeva

London Business School

Jenny Tang

Federal Reserve Banks - Federal Reserve Bank of Boston

Date Written: December, 2020

Abstract

This paper presents new stylized facts about exchange rates and their relationship with macroeconomic fundamentals. We show that macroeconomic surprises explain a large majority of the variation in nominal exchange rate changes at a quarterly frequency. Using a novel present value decomposition of exchange rate changes that is disciplined with survey forecast data, we show that macroeconomic surprises are also a very important driver of the currency risk premium component and explain about half of its variation. These surprises have even greater explanatory power during economic downturns and periods of financial uncertainty.

Keywords: exchange rates, exchange rate disconnect, macroeconomic announcements, international finance, professional forecasts

JEL Classification: E44, F31, G14, G15

Suggested Citation

Stavrakeva, Vania and Tang, Jenny, A Fundamental Connection: Exchange Rates and Macroeconomic Expectations (December, 2020). FRB of Boston Working Paper No. 20-20, Available at SSRN: https://ssrn.com/abstract=3887178 or http://dx.doi.org/10.29412/res.wp.2020.20

Vania Stavrakeva (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Jenny Tang

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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