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Monetary Policy and Currency Returns: the Foresight Saga

Listed author(s):
  • Borisenko, Dmitry
  • Pozdeev, Igor

    ()

We document a drift in exchange rates before monetary policy changes across major economies. Currencies tend to depreciate by 0.7 percent over ten days before policy rate cuts and appreciate by 0.5 percent before policy rate increases. We show that available fixed income instruments allow to accurately forecast monetary policy decisions and thus that the drift is foreseeable and exploitable by investors. A simple trading strategy buying currencies against USD ten days ahead of predicted local interest rate hikes and selling currencies before predicted cuts earns on average a statistically significant return of 42 basis points per ten-day period. We further demonstrate that this return is robust to the choice of holding horizon and monetary policy forecast rule. Our results thus pose a major challenge for the risk-based explanations of the exchange rate dynamics.

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File URL: http://ux-tauri.unisg.ch/RePEc/usg/sfwpfi/WPF-1708.pdf
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Paper provided by University of St. Gallen, School of Finance in its series Working Papers on Finance with number 1708.

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Length: 46 pages
Date of creation: May 2017
Date of revision: 1710
Handle: RePEc:usg:sfwpfi:2017:08
Contact details of provider: Phone: +41 71 243 40 11
Fax: +41 71 243 40 40
Web page: http://www.unisg.ch/de/universitaet/schools/finance

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