4.7 Article

Understanding exchange rate shocks during COVID-19

Journal

FINANCE RESEARCH LETTERS
Volume 45, Issue -, Pages -

Publisher

ACADEMIC PRESS INC ELSEVIER SCIENCE
DOI: 10.1016/j.frl.2021.102181

Keywords

Exchange rate; Shocks; Spillover; COVID-19

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The study finds that 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. Exchange rate own shocks explain between 56% to 75% of own exchange rate movements, indicating that exchange rates can predict most of their own changes.
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.

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