Exchange Rate Market Expectations and Central Bank Policy: The Case of the Mexican Peso/U.S. Dollar from 2005–2009

This article examines two approaches characterized by different tail features to extract market expectations on the Mexican peso/US dollar exchange rate. The methods used to estimate risk-neutral densities are the volatility function technique (VFT) proposed by Malz and the generalized extreme value...

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Bibliographic Details
Published in:The Journal of derivatives 2012-07, Vol.19 (4), p.70-90
Main Authors: Abarca, Gustavo Lesser, Benavides, Guillermo, Rangel, José Gonzalo
Format: Article
Language:English
Subjects:
Comparative analysis
Foreign exchange markets
Foreign exchange rates
Monetary policy
Studies
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Summary:This article examines two approaches characterized by different tail features to extract market expectations on the Mexican peso/US dollar exchange rate. The methods used to estimate risk-neutral densities are the volatility function technique (VFT) proposed by Malz and the generalized extreme value (GEV) approach suggested by Figlewski. The authors compare these methods in the context of monetary policy announcements in Mexico and the US. They find evidence that US surprises, which are measured following Kuttner, have significant effects on exchange rate variations. Around event days in Mexico and the US, the results also indicate that although both VFT and GEV suggest similar dynamics at the center of the distribution, these two methods show significantly different patterns in the tails. Their empirical evidence shows that given its unique procedure that allows for longer asymptotically well-behaved tails, the GEV approach better captures the extreme values of the distribution around monetary policy event days.
ISSN:1074-1240
2168-8524
DOI:10.3905/jod.2012.19.4.070