Monetary Policy and Currency Returns: the Foresight Saga

Item Type Monograph (Working Paper)
Abstract

We document a drift in exchange rates before monetary policy changes across major economies. Currencies tend to depreciate by 0.7 percent over ten days before policy rate cuts and appreciate by 0.5 percent before policy rate increases. We show that available fixed income instruments allow to accurately forecast monetary policy decisions and thus that the drift is foreseeable and exploitable by investors. A simple trading strategy buying currencies against USD ten days ahead of predicted local interest rate hikes and selling currencies before predicted cuts earns on average a statistically significant return of 42 basis points per ten-day period. We further demonstrate that this return is robust to the choice of holding horizon and monetary policy forecast rule. Our results thus pose a major challenge for the risk-based explanations of the exchange rate dynamics.

Authors Borisenko, Dmitry & Pozdeev, Igor
Language English
Keywords Monetary Policy, Policy Expectations, Predictability, Overnight Index Swap, Foreign Exchange
Subjects finance
HSG Profile Area None
Date May 2017
Publisher SoF - HSG
Place of Publication St. Gallen
Series Name School of Finance Working Paper Series
Volume 2017/08
Number 08
Number of Pages 31
Depositing User Geraldine Frei-Böbel
Date Deposited 08 Jun 2017 11:17
Last Modified 30 Jun 2017 12:58
URI: https://www.alexandria.unisg.ch/publications/250986

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Citation

Borisenko, Dmitry & Pozdeev, Igor: Monetary Policy and Currency Returns: the Foresight Saga. School of Finance Working Paper Series, 2017, 08.

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https://www.alexandria.unisg.ch/id/eprint/250986
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