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Response of tail risks of Euro-dollar exchange rate to monetary policy shocks in the US and the Euro area using penalized local projections

Author

Listed:
  • Hyejin Yang

    (University of Michigan)

  • Jin Lee

    (Ewha Womans University)

Abstract

We estimate the impact of depreciation risks in the dollar per Euro exchange rate in response to both monetary policy shocks and central bank information shocks originating from the US and the Euro area. We utilize various sign restrictions on high-frequency data to effectively identify the shocks. To estimate the impulse responses, we employ the local projection methods along with the double lasso shrinkage procedure for control variables. It is found that monetary policy shocks result in the anticipated effects on the tail risk of dollar per Euro exchange rate solely during the contemporaneous period, irrespective of the structures of sign restrictions. In certain cases, reduction of tail risks is found in one to three-quarters after instances of tightening in US monetary policy, implying possible Euro’s characteristics of a safe haven asset. We also observe that US central bank information shocks decrease the exchange rate risks in the immediate period, promptly becoming insignificant thereafter.

Suggested Citation

  • Hyejin Yang & Jin Lee, 2025. "Response of tail risks of Euro-dollar exchange rate to monetary policy shocks in the US and the Euro area using penalized local projections," SN Business & Economics, Springer, vol. 5(6), pages 1-21, June.
    • Handle: RePEc:spr:snbeco:v:5:y:2025:i:6:d:10.1007_s43546-025-00836-5
    DOI: 10.1007/s43546-025-00836-5
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    Keywords

    Dollar per Euro exchange rate tail risk; Monetary policy shocks; Impulse response analysis; Local projections; Penalized regressions;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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