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Exchange rates dependence: what drives it?

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  • Sigridur Benediktsdottir
  • Chiara Scotti

Abstract

Exchange rate movements are difficult to predict but there appear to be discernible patterns in how currencies jointly appreciate or depreciate against the dollar. In this paper, we study the dependence structure of a number of exchange rate pairs against the dollar. We employ a conditional copula approach to recover the joint distributions for pairs of exchange rates and study both the correlation and the upper and lower tail dependence of these distributions. We analyze changes in dependence measures over time, and we investigate whether these measures are affected by the business cycle or interest rate differentials. Our results show that dependencies are indeed time-varying. We find that foreign and U.S. recessions affect the joint dependence structure and that currencies with higher interest rate differentials tend to move less closely together, not only on average (correlation), but also when extreme events occur (tails).

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 969.

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Date of creation: 2009
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Handle: RePEc:fip:fedgif:969

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Cited by:
  1. Rubén Albeiro Loaiza Maya & Luis Fernando Melo Velandia, 2012. "Latin American Exchange Rate Dependencies: A Regular Vine Copula Approach," BORRADORES DE ECONOMIA 009902, BANCO DE LA REPÚBLICA.
  2. Li, Xiao-Ming, 2011. "How do exchange rates co-move? A study on the currencies of five inflation-targeting countries," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 418-429, February.

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