The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Ravi Balakrishnan, Stefan Laseen, and Andrea Pescatori
INTERNATIONAL MONETARY FUND
We investigate the drivers of dynamics of major U.S. FX bilaterals. We first construct a
novel measure of FX risk premiums using Consensus exchange rate forecasts. We then
use VAR analysis to show that (i) risk premium shocks play a key role in driving
dynamics of the major U.S. FX bilaterals; (ii) longer-term interest differentials also
matter, especially for the Canadian $ and the Euro; (iii) oil price shocks play a particularly
important role for the Canadian $ (an oil exporter); and (iv) risk appetite shocks (e.g., VIX
shocks) generally lead to U.S. dollar appreciation. The importance of risk premium and
longer-term interest differential shocks fit well with a simple theoretical model and are
supported by recent event studies.