||How the Federal funds target rate announcement affects the foreign exchange rate? The case of US dollar and Euro
||Graduate Institute of Finance
Interest rates term structure
Uncovered interest rate parity (UIRP)
近日，景氣漸漸復甦，是否調升聯邦基金目標利率成為注目的議題。調整聯邦基金目標利率，不僅會影響美國短期利率，也會影響整體經濟。當聯邦基金目標利率上升或下降，匯率(美元/歐元)會如何變化? 此外我們結合(隨機運動)利率期限結構 – 單因子Cox-Ingersoll-Ross (CIR)模型，與利率平價理論來進行我們的研究。設定聯邦基金目標利率改變時為事件日，利用前六天的市場資訊，帶入CIR模型，求出參數，來預估美國及歐洲的個別短期利率。接下來使用利率平價理論，將預測的利率轉換成匯率(美元/歐元)。樣本期間為06/21/2006~04/08/2016，最後我們評估模型的預測能力，選擇最好的預測模型。此研究發現當美國宣告聯邦基金利率為上升或下降，歐洲也會跟著調整利率，但個別利率調整的幅度不同，造成匯率並不會有一致的方向，另外使用CIR模型確實比只使用簡單的IRP模型預測力還要好，且在CIR模型短期利率使用聯邦基金目標利率預測力較使用實際利率準確。
Recently, the issue as to whether federal funds target rates will rise or remain stable has become popular. Changes in the federal funds target rate will not only influence the short rate in the market, but will also affect overall economic conditions. How exchange rates in the U.S. and Europe will change when the federal funds target rate fluctuates is a very interesting topic. Moreover, we combine the stochastic movement of term structure - one factor Cox-Ingersoll-Ross (CIR) model with interest rate parity to conduct our research. We set the federal funds target rates announcement as the basis date, use ex ante six business day information and strips (Separate Trading of Registered Interest and Principal of Securities) to calibrate the CIR parameters, and estimate the U.S. and Euro ex post interest rates. We then use the interest rate parity to transfer the estimated interest rates into exchange rates. The sample data is from June 21, 2006 to April 8, 2016. Furthermore, we measure the model of predictive power, compare it with alternative models, and choose the best prediction model. In our results, we find that exchange rates don’t have same direction when the federal funds target rate changes, which might cause interest rates for the euro area to change after the interest rate in the U.S. changes. Furthermore, the CIR model is better than using only the IRP model and federal funds target rate as the instantaneous rate in the CIR model because it is more precise.
LIST OF TABLE IV
LIST OF FIGURE VI
I. INTRODUCTION 1
II. LITERATURE REVIEW 3
2.1 THE TERM STRUCTURE OF THE INTEREST RATES MODEL 3
2.2 UNCOVERED INTEREST RATE PARITY 5
III. METHODOLOGY 8
3.1 THE ONE-FACTOR COX-INGERSOLL-ROSS MODEL 8
3.1.1 CALIBRATION AND ESTIMATION OF THE PARAMETERS OF THE COX-INGERSOLL-ROSS MODEL 10
3.1.2 PREDICTED U.S./EURO EXCHANGE RATE USING THE CIR MODEL 13
3.2 EVALUATING THE PREDICTIVE POWER AMONG MODELS 14
IV. DATA 17
4.1 DATA STATISTICAL SUMMARY 17
4.2 UNIT ROOT TEST 20
V. EMPIRICAL RESULTS 22
5.1 THE PARAMETERS OF THE CIR MODEL 22
5.2 THE ESTIMATED EXCHANGE RATES BY THE CIR MODELS 27
5.3 PREDICTIVE POWER OF THE MODELS 33
VI. CONCLUSIONS 38
VII. REFERENCES 40
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