Liquidity and Exchange Rates: An Empirical Investigation

Charles Engel and Steve Pak Yeung Wu

No 25397, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We find strong empirical evidence that economic fundamentals can well account for nominal exchange rate movements. The important innovation is that we include the liquidity yield on government bonds as an explanatory variable. We find impressive evidence that changes in the liquidity yield are significant in explaining exchange rate changes for all of the G10 countries. Moreover, after controlling for liquidity yields, traditional determinants of exchange rates – adjustment toward purchasing power parity and monetary shocks – are also found to be economically and statistically significant. We show how these relationships arise out of a canonical two-country New Keynesian model with liquidity returns. Additionally, we find a role for sovereign default risk and currency swap market frictions.

JEL-codes: F31 F41 (search for similar items in EconPapers)
Date: 2018-12
New Economics Papers: this item is included in nep-mon and nep-opm
Note: IFM
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Citations: View citations in EconPapers (45)

Published as Charles Engel & Steve Pak Yeung Wu, 2023. "Liquidity and Exchange Rates: An Empirical Investigation," The Review of Economic Studies, vol 90(5), pages 2395-2438.

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Related works:
Journal Article: Liquidity and Exchange Rates: An Empirical Investigation (2023)
Working Paper: Liquidity and Exchange Rates: An Empirical Investigation (2023)
Working Paper: Liquidity and Exchange Rates - An Empirical Investigation (2018)
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