Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange

Abstract

Using a new dataset consisting of six years of real-time exchange rate quotations, macroeconomic expectations, and macroeconomic realizations (announcements), we characterize the conditional means of U.S. dollar spot exchange rates versus German Mark, British Pound, Japanese Yen, Swiss Franc, and the Euro. In particular, we find that announcement surprises (that is, divergences between expectations and realizations, or "news") produce conditional mean jumps; hence high-frequency exchange rate dynamics are linked to fundamentals. The details of the linkage are intriguing and include announcement timing and sign effects. The sign effect refers to the fact that the market reacts to news in an asymmetric fashion: bad news has greater impact than good news, which we relate to recent theoretical work on information processing and price discovery.

Nonlinear prediction of exchange rates with monetary fundamentals

“…Rapach and Wohar (in press) examine the relationship between exchange rates and monetary fundamentals for 14 countries over very long time spans and find substantial evidence for the importance of fundamentals. Anderson et al (2001) find a linkage between macroeconomic news and intraday exchange rate movements. Kilian and Taylor (2001) embody smooth threshold dynamics to capture nonlinear mean reversion of exchange rates and report that exchange rates are forecastable over the long horizons (2 -3 years) but not at the short horizons.…”

DOES INFLATION TARGETING ANCHOR LONG-RUN INFLATION EXPECTATIONS? EVIDENCE FROM THE U.S., UK, AND SWEDEN4

“…13. The quality of the MMS data as measures of expectations has been verified by previous authors-see, for example, Balduzzi, Elton, and Green (2001) and Andersen et al (2003). 14.…”

Individual Exchange Rate Forecasts and Expected Fundamentals

“…Subsequent to the devastating result of Meese and Rogoff (1983), which showed the failure of exchange rate models in an out-of-sample forecasting context in comparison to a random walk model, the linkage of exchange rates to fundamentals has now been demonstrated to hold at very short and at the long horizon: at very short-term horizons, exchange rates clearly and systematically react to fundamentals, as many event studies have examined in detail (e.g., Andersen, Bollerslev, Diebold, and Vega, 2003), while at long-term horizons, exchange rates are attracted to the purchasing power parity level and, related to this, seem to be tentatively in line with the 4 monetary model (e.g., Mark, 1995;Taylor and Taylor, 2004). Thus, it is the medium-term horizon where it is most difficult to show a clear relationship between fundamentals and exchange rates (Rogoff, 2007).…”

“…At intermediate horizons, such as a month or half a year ahead, exchange rates seem to be hardly explained and, in particular, seem to be disconnected from fundamentals (Obstfeld and Rogoff, 2000). This disconnect is surprising, given the fact that foreign exchange markets react to changes in economic fundamentals within minutes (Andersen, Bollerslev, Diebold, and Vega, 2003) and that exchange rates reflect long-term changes in purchasing power (Taylor and Taylor, 2004). At intermediate horizons, however, the relationship between fundamentals and exchange rates seems to be largely unobservable, possibly even non-existent (Frankel and Rose, 1995;Rogoff, 2007).…”