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Exchange rates and monetary policy uncertainty

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  • Mueller, Philippe
  • Tahbaz-Salehi, Alireza
  • Vedolin, Andrea

Abstract

We document that a trading strategy that is short the U.S. dollar and long other currencies exhibits significantly larger excess returns on days with scheduled Federal Open Market Committee (FOMC) announcements. We show that these excess returns (i) are higher for currencies with higher interest rate differentials vis-à-vis the United States, (ii) increase with uncertainty about monetary policy, and (iii) increase further when the Federal Reserve adopts a policy of monetary easing. We interpret these excess returns as compensation for monetary policy uncertainty within a parsimonious model of constrained financiers who intermediate global demand for currencies.

Suggested Citation

  • Mueller, Philippe & Tahbaz-Salehi, Alireza & Vedolin, Andrea, 2017. "Exchange rates and monetary policy uncertainty," LSE Research Online Documents on Economics 77256, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:77256
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    More about this item

    Keywords

    currency risk; liquidity; markets; ES/K002309/1;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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