Understanding exchange rate shocks during COVID-19

https://doi.org/10.1016/j.frl.2021.102181Get rights and content

Highlights

  • A dynamic VAR model fitted to hourly data to evaluate the evolution of spillover shocks from exchange rates.

  • Exchange rates (CAD, JPY, EURO and GBP) predict most of their own changes.

  • Shock spillovers predict exchange rate returns.

  • Predicted exchange rates can be useful in extracting buy and sell trading signals.

Abstract

Using a dynamic VAR model fitted to hourly data, we evaluate the evolution of spillover shocks from exchange rates returns of EURO, Yen, CAD and GBP. We find that over the COVID-19 sample: (a) total exchange rate shock spillovers explain around 37.7% of the forecast error variance in the exchange rate market compared to only 26.1% in the pre-COVID-19 period; and (b) exchange rate own shocks explain between 56% to 75% of own exchange rate movements. These results hold in multiple robustness tests. The implication is that exchange rates predict most of their own changes. We confirm this through an economic significance test where we show that the shock spillovers predict exchange rate returns and these predicted exchange rates can be useful in extracting buy and sell trading signals.

Keywords

Exchange rate
Shocks
Spillover
COVID-19

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