Monetary policy and currency returns : the foresight saga

This thesis contributes to three major fields in the international finance literature: forward premium anomaly, monetary policy and exchange rate determination, and measuring monetary policy expectations from asset prices. In the second chapter (jointly with Igor Pozdeev), we document a drift in exchange rates before monetary policy changes across major economies. Currencies tend to depreciate by 0.8% over ten days before policy rate cuts and appreciate by 0.5% before policy rate increases. We show that available fixed income instruments allow to forecast monetary policy decisions and thus that the drift is exploitable by investors. Buying (selling) currencies ten days in advance of predicted target rate hikes (cuts) earns on average a statistically significant excess return of over 40 basis points per ten-day period after trading costs. We further demonstrate that this return is robust to the choice of holding horizon and monetary policy forecast rule. Our results thus pose a major challenge for the risk-based explanations of the exchange rate dynamics.