Exchange Rate Disconnect Redux

Ryan Chahrour, Vito Cormun, Pierre De Leo (), Pablo Guerron and Rosen Valchev

No 1041, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: We find that variation in expected US productivity explains more than half of G6 exchange rate fluctuations vis-a-vis the USD. Both correctly-anticipated changes in productivity and expectational “noise”, which influences expected productivity but never its realization, play an important role in driving exchange rates. Together, these disturbances account for many unconditional exchange rate patterns, including predictable excess returns, low Backus-Smith correlations, and excess volatility. Our findings suggest these famous puzzles share a common empirical origin, one that is very much connected to (expected) fundamentals. All of these findings can be rationalized by a model in which excess currency returns are driven by endogenously-fluctuating bond convenience yields. This mechanism makes additional predictions about government debt dynamics that prove true in the data.

Keywords: Exchange Rate Disconnect; TFP News; Excess Returns; Excess Volatility (search for similar items in EconPapers)
JEL-codes: D8 F3 G1 (search for similar items in EconPapers)
Date: 2021-11-05
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