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Noisy news and exchange rates: A SVAR approach

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  • Redl, Chris

Abstract

This paper introduces noisy news shocks into a model of exchange rate determination to measure the impact of these shocks using a SVAR. Agents in the foreign exchange market make decisions with imperfect information about economic fundamentals driving interest rate differentials between countries in that they must rely on a noisy signal of future interest rates. I apply the framework to the USD/GBP nominal exchange rate for the period 1986–2013. Results show that noisy-news explains approximately one fifth of the forecast error variance in the nominal exchange rate, with noise accounting for double (12%) that of news (6%). A historical decomposition of the exchange rate indicates that noise shocks are especially important during periods of changing monetary policy, e.g. the 1990 easing and 2001 tightening of U.S. monetary policy and the unconventional monetary policies surrounding the financial crisis of 2008.

Suggested Citation

  • Redl, Chris, 2015. "Noisy news and exchange rates: A SVAR approach," Journal of International Money and Finance, Elsevier, vol. 58(C), pages 150-171.
    • Handle: RePEc:eee:jimfin:v:58:y:2015:i:c:p:150-171
    DOI: 10.1016/j.jimonfin.2015.08.002
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    More about this item

    Keywords

    Exchange rates; SVAR; News; Noise; Nonfundamentalness; Invertibility;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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