The overall aim of this paper is first to review existing papers and based on this to conduct own research in the field of the effect of macroeconomic news in general and, more specific,
ECB communication on exchange rates.
Exchange rate communication is a special form of macroeconomic news that is issued by central banks. Existing research on the effect of this communication has lead to often diverging result that illustrate the high intensity and dynamics of the current academic debate with regard to this matter. On one hand evidence of a relatively high impact on the mean and volatility of currency markets is found (e.g. by Fratzscher (2004)) whereas others (e.g. Jansen, de Haan (2005)) do not chronicle statistically significant and persistent results. The difficulty of understanding the response of currency markets becomes even harder when the significance of the respective context of news e.g. day of the week effect is considered or asymmetric responses are taken into account.
Among the group of central banks especially the European Central Bank has attracted high attention in academic research. Preceding studies generally create dummy variables to measure ECB communication. These variables are then by different methods regressed against the exchange rate or other financial assets in order to find explanatory relationships. This paper follows this approach by using the dummy variable of Rosa, Verga (2006).
Ultimately we arrive at three major findings using our dataset. (a) Communication and interest changes by central banks are interpreted differently by currency markets: While
communication that suggests raising interest rates seems to be an alarming warning signal with regard to possible inflation, interest rate increases see to be interpreted as attempts to mitigate this danger. (b) There are indicators that the exchange rate reacts more slowly to news coming from the U.S. (c) Based not on high frequency but on daily data we merely arrive at results that do not allow us to reject the null hypothesis that exchange rate communication actually does not have a significant impact on exchange rate returns.
Table of Content
1. Introduction
2. How do markets react to macro news?
2.1. What is news and how does it affect the mean and volatility of exchange rates?
2.2. Velocity of news absorption
2.3. Context of news: What impact does it have?
2.4. Asymmetric reaction to news
3. Central Banks
3.1. Why are Central Banks and especially the ECB of special academic interest?
3.2. How can we classify the existing research in the ECB-field?
3.3. What can central banks achieve by communication?
4. Empirical Evidence for exchange rate communication efficiency
4.1. Which existing papers have similar empirical focus?
4.2. How do existing papers measure communication?
4.3. What econometric methodology has been used?
4.4. What effects could the existing research discover?
4.5. What do those results mean for the actions of the ECB?
5. Own empirical findings
5.1. Data sources
5.2. Which is the most appropriate regression?
5.3. Why could lag specification be helpful?
5.4. What is the economic reasoning behind the sign and the size of the coefficients?
5.5 Which results does further testing yield?
5.6 Interpretation of Results / Implications for ECB
6. Conclusion
7. References
8. Tables
9. Graphs
Objectives and Topics
This paper aims to analyze whether communication from the European Central Bank (ECB) exerts a statistically significant influence on the Euro/Dollar exchange rate. By reviewing existing literature and conducting an independent empirical analysis using Ordinary Least Squares (OLS) regression, the study seeks to bridge the gap between theoretical expectations of market efficiency and the observed difficulties in detecting consistent, long-term impacts of central bank statements on daily exchange rate returns.
- The theoretical and empirical analysis of currency market responses to macroeconomic news.
- The evaluation of the European Central Bank's role and its communication strategy in financial markets.
- A critical review of econometric methodologies used in previous studies to measure communication efficiency.
- Empirical investigation of the causal relationship between ECB communication dummies and Euro/Dollar exchange rate movements.
- Interpretation of the role of interest rate changes and their lagged effects in explaining currency fluctuations.
Excerpt from the Book
5.1. Data sources
As already explained in part 4.2 we intend to put the Rosa, Verga data set to further use. This data set measures the content of the introductory statement that is made at the beginning of the monthly press conferences of the President of the ECB. From this Rosa, Verga (2006) construct an index that codes the content of the statements by creating a “wording indicator” which is converted into a five-value variable. The authors explain:
The value of zero suggests that the current level of the Repo rate is appropriate to maintain price stability over the medium term. The value -1 characterizes an easing period: it is possible that the Repo rate will be cut in the near future. The value -2 indicates that the Governing Council is increasingly inclined to cut interest rates. The values +1 (+2) characterize a (strong) likelihood of future monetary policy tightening.
If the above outlined theory holds we can expect that at the moment when the announcement about future Repo changes is made the market will incorporate this news in prices and the exchange rate should be affected. According to market efficiency hypothesis this process should occur fairly quickly so a change in the exchange rate should be expected to occur on the same day. For this reason we think the chosen dummy variable as a good surrogate to test if communication can actually have an effect on exchange rates.
Summary of Chapters
1. Introduction: Outlines the paper's objective to analyze the impact of ECB communication on the Euro/Dollar exchange rate and provides the structure for the following analysis.
2. How do markets react to macro news?: Defines "news" in a scientific context and explores theoretical perspectives on how financial markets absorb and react to unexpected information.
3. Central Banks: Examines why central banks, particularly the ECB, attract significant academic interest due to their role in conveying information and influencing market parameters.
4. Empirical Evidence for exchange rate communication efficiency: Critically reviews existing literature, comparing different proxies, datasets, and econometric methodologies used to evaluate the effectiveness of central bank communication.
5. Own empirical findings: Presents the results of the author's OLS regression analysis, detailing data sources, specification tests, and the interpretation of statistical coefficients regarding exchange rate movements.
6. Conclusion: Summarizes the key findings, acknowledging the methodological limitations while discussing the implications of the results for the ECB's communication policy.
Keywords
European Central Bank, ECB, communication, exchange rate, Euro/Dollar, macroeconomic news, monetary policy, market efficiency, OLS regression, volatility, interest rate, economic indicators, financial markets, econometric methodology, currency markets
Frequently Asked Questions
What is the core focus of this research paper?
The paper focuses on investigating whether communication from the European Central Bank (ECB) has a measurable impact on the daily movements of the Euro/Dollar exchange rate.
What are the primary themes discussed in the study?
Key themes include the theoretical definition of news in financial markets, the role of central bank transparency, the evaluation of econometric techniques for measuring communication effects, and the empirical analysis of Euro/Dollar exchange rate data.
What is the main research question?
The central research question is whether central bank communication effectively influences exchange rate returns and whether this can be empirically verified using daily data through an OLS regression approach.
Which scientific methods are employed?
The study primarily employs OLS (Ordinary Least Squares) regression analysis and a series of diagnostic econometric tests, including the Dickey-Fuller test, White Heteroskedasticity test, and Breusch-Godfrey test.
What is covered in the main body of the work?
The main body covers the definition and classification of news, a literature review of ECB communication research, a detailed description of the empirical model and dataset, and an interpretation of the resulting econometric findings.
Which keywords characterize this paper?
The paper is characterized by terms such as ECB communication, exchange rate dynamics, market efficiency, monetary policy, and OLS regression.
How does the author define "news" in the context of the ECB?
The author considers any unexpected announcement or communication from the ECB as "news," which implies that the market should theoretically incorporate this information into prices upon release.
Why does the paper include a comparison of "tick-by-tick" data versus daily data?
The comparison is included to explain why other studies (like Rosa, Verga, 2006) might find significant results that this paper's analysis—relying on daily data—does not, highlighting the impact of data frequency on research outcomes.
- Citation du texte
- Andreas Grün (Auteur), Thomas Lange (Auteur), 2007, Theoretical and Empirical Analysis of Exchange Rate Communication, Munich, GRIN Verlag, https://www.grin.com/document/178413
