Investor reactions to news: an analysis of the euro-dollar exchange rate

This paper investigates whether the fall in the euro-dollar exchange rate in the course of 2000 can be partly attributed to asymmetric reactions by investors to economic and political news. We have studied the daily euro-dollar exchange rate changes recorded from 1 April 2000 to the first co-ordinated exchange rate intervention on 22 September 2000, regressing these changes on economic and political news items about the US and the euro area. The paper suggests that investors' response to news about the US differs from that to news about the euro area. Specifically, the exchange rate did not respond to economic news about the euro area, whereas it did to US economic news. There are indications that the opposite holds true in respect of political news. Moreover, the paper shows a difference in the magnitude in the reaction to 'good' and 'bad' news items, which may suggest some additional news filtering by investors (cognitive dissonance). These asymmetric reaction pattern may explain at least partly why, contrary to what exchange rate theory would predict, the recovery of the economy in the euro area in the course of 2000 was not followed by an appreciation of the euro vis-à-vis the dollar. Importantly, given the relevance of political euro area news to investors, politicians and central bankers face the challenge to convince market participants of the viability of EMU.