U.S. Dollar Dynamics: How Important Are Policy Divergence and FX Risk Premiums?

By Ravi Balakrishnan, Stefan Laseen, Andrea Pescatori

July 5, 2016

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Format: Chicago

Ravi Balakrishnan, Stefan Laseen, and Andrea Pescatori. U.S. Dollar Dynamics: How Important Are Policy Divergence and FX Risk Premiums?, (USA: International Monetary Fund, 2016) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

We investigate the drivers of dynamics of major U.S. FX bilaterals. We first construct a novel measure of FX risk premiums using Consensus exchange rate forecasts. We then use VAR analysis to show that (i) risk premium shocks play a key role in driving dynamics of the major U.S. FX bilaterals; (ii) longer-term interest differentials also matter, especially for the Canadian $ and the Euro; (iii) oil price shocks play a particularly important role for the Canadian $ (an oil exporter); and (iv) risk appetite shocks (e.g., VIX shocks) generally lead to U.S. dollar appreciation. The importance of risk premium and longer-term interest differential shocks fit well with a simple theoretical model and are supported by recent event studies.

Subject: Exchange rate adjustments, Exchange rate risk, Exchange rates, Financial regulation and supervision, Foreign exchange, National accounts, Return on investment

Keywords: Assets vis, C. risk premium estimate, Constructed risk premium, Exchange rate adjustments, Exchange rate movement, Exchange rate risk, Exchange rates, Exogenous risk premium process, Foreign exchange, FX risk premium, Global, Monetary policy shock, Monetary policy shocks, Return on investment, Risk premium, SVAR, U.S. dollar, WP

Publication Details

Pages:

47
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2016/125
Stock No:

WPIEA2016125
ISBN:

9781498348416
ISSN:

1018-5941

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