Real exchange rate decompositions

We provide a novel daily decomposition of the real exchange rate that exploits a direct link between bond and foreign exchange (FX) markets. Real exchange rate dynamics can be attributed to changes in the expected future level of the exchange rate; cross-country differentials of expected inflation, yields and bond term premia; and an FX risk premium. Through a variance decomposition exercise, we find that the FX risk premium is the dominant component. Monetary policies and macroeconomic news announcements largely move the real exchange through changes in the FX risk premium.

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Year of publication:	2022
Authors:	Feunou, Bruno ; Fontaine, Jean-Sébastien ; Krohn, Ingomar
Publisher:	Ottawa : Bank of Canada
Subject:	Asset pricing \| Exchange rates \| International financial markets \| Monetary policy transmission

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Series:	Bank of Canada Staff Discussion Paper ; 2022-6
Type of publication:	Book / Working Paper
Type of publication (narrower categories):	Working Paper
Language:	English
Other identifiers:	10.34989/sdp-2022-6 [DOI] 1799805840 [GVK] hdl:10419/266067 [Handle]
Classification:	E43 - Determination of Interest Rates; Term Structure Interest Rates ; F31 - Foreign Exchange ; G12 - Asset Pricing
Source:	EconStor

Persistent link: https://www.econbiz.de/10013430324