News sentiment and overshooting of exchange rates

Stefan Feuerriegel, Georg Wolff and Dirk Neumann

Applied Economics, 2016, vol. 48, issue 44, 4238-4250

Abstract: In a globalized world, the volume of international trade is based on both import and export prices, thereby making a country’s economy highly dependent on exchange rates. In order to study exchange rate movements, one frequently exploits the so-called Dornbusch overshooting model. However, the model is controversial from a theoretical point of view: it explains exchange rate movements by a number of fundamental variables but ignores how novel information in the form of news can enter the market. As a remedy, this article adjusts for information dissemination by performing a multivariate analysis to compare the classical overshooting model with an extended variant that includes news sentiment. Our results show that news sentiment has a substantial explanatory power of 11% of the exchange rate forecasting error variance. In addition, we also find statistical evidence that a shock in news sentiment may lead to overshooting.

Date: 2016
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DOI: 10.1080/00036846.2016.1153796

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