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Risk, Monetary Policy and the Exchange Rate

  • Gianluca Benigno
  • Pierpaolo Benigno
  • Salvatore Nisticò

In this research, we provide new empirical evidence on the importance of time-varying uncertainty for the exchange rate and the excess return in currency markets. Following an increase in monetary policy uncertainty, the dollar exchange rate appreciates in the medium run, while an increase in the volatility of productivity leads to a dollar depreciation. We propose a general-equilibrium theory of exchange rate determination based on the interaction between monetary policy and time-varying uncertainty aimed at understanding these regularities. In the model, the behaviour of the exchange rate following nominal and real volatility shocks is consistent with the empirical evidence. Furthermore we show that risk factors and interest-rate smoothing are important in accounting for the negative coefficient in the UIP regression.

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File URL: http://www.nber.org/papers/w17133.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17133.

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Date of creation: Jun 2011
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Publication status: published as Gianluca Benigno & Pierpaolo Benigno & Salvatore Nistic�, 2012. "Risk, Monetary Policy, and the Exchange Rate," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 247 - 309.
Handle: RePEc:nbr:nberwo:17133
Note: AP EFG IFM ME
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Lombardo, Giovanni & Sutherland, Alan, 2005. "Computing second-order-accurate solutions for rational expectation models using linear solution methods," Working Paper Series 0487, European Central Bank.
  2. Gianluca Benigno & Pierpaolo Benigno & Salvatore Nistico, 2011. "Second-Order Approximation of Dynamic Models with Time-Varying Risk," FMG Discussion Papers dp677, Financial Markets Group.
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  8. Maurice J. Roche & Michael J. Moore, 2007. "Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs," Economics, Finance and Accounting Department Working Paper Series n1750507, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  9. Hess, Gregory & Shin, Kwanho, 2006. "Understanding the Backus-Smith Puzzle: It’s the (Nominal) Exchange Rate, Stupid," MPRA Paper 696, University Library of Munich, Germany.
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  12. Adrien Verdelhan, 2005. "A Habit-Based Explanation of the Exchange Rate Risk Premium," Boston University - Department of Economics - Working Papers Series WP2005-032, Boston University - Department of Economics.
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  15. Jesus Fernández-Villaverde & Pablo Guerrón-Quintana & Juan F. Rubio-Ramírez, 2010. "Fortune or virtue: time-variant volatilities versus parameter drifting," Working Papers 10-14, Federal Reserve Bank of Philadelphia.
  16. Pierpaolo Benigno & Salvatore Nistic�, 2012. "International Portfolio Allocation under Model Uncertainty," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(1), pages 144-89, January.
  17. John F. O. Bilson, 1980. "The "Speculative Efficiency" Hypothesis," NBER Working Papers 0474, National Bureau of Economic Research, Inc.
  18. Eric T. Swanson, 2012. "Risk Aversion and the Labor Margin in Dynamic Equilibrium Models," American Economic Review, American Economic Association, vol. 102(4), pages 1663-91, June.
  19. Glenn D. Rudebusch & Eric T. Swanson, 2008. "The bond premium in a DSGE model with long-run real and nominal risks," Working Paper Research 143, National Bank of Belgium.
  20. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
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  22. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
  23. David K. Backus & Federico Gavazzoni & Christopher Telmer & Stanley E. Zin, 2010. "Monetary Policy and the Uncovered Interest Parity Puzzle," NBER Working Papers 16218, National Bureau of Economic Research, Inc.
  24. Benigno, Gianluca & Benigno, Pierpaolo, 2008. "Exchange rate determination under interest rate rules," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 971-993, October.
  25. Pesaran, M. Hashem & Smith, Ron, 1995. "Estimating long-run relationships from dynamic heterogeneous panels," Journal of Econometrics, Elsevier, vol. 68(1), pages 79-113, July.
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