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U.S. Dollar Dynamics: How Important Are Policy Divergence and FX Risk Premiums?
Author: Mr. Ravi Balakrishnan, Stefan Laseen, and Mr. Andrea Pescatori
Series:
IMF Working Papers
Volume/Issue:
Volume 2016: Issue 125
Language:
English
Publication Date:
05 Jul 2016
DOI:
https://doi.org/10.5089/9781498348416.001
ISBN:
9781498348416
ISSN:
1018-5941
Pages:
47
Keywords:
WP; risk premium; FX risk premium; U.S. dollar; Foreign exchange; monetary policy shocks; SVAR; monetary policy shock; C. risk premium estimate; exogenous risk premium process; constructed risk premium; assets vis; exchange rate movement; Return on investment; Exchange rates; Exchange rate risk; Exchange rate adjustments; Global
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IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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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.
Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund

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