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OP 2005/38 András Rezessy: Estimating the immediate impact of monetary policy shocks on the exchange rate

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Abstract

The paper estimates the immediate impact of Hungarian monetary policy on three

classes of asset prices: the exchange rate of the forint vis-ŕ-vis the euro, spot and forward government bond yields and the index of the Budapest Stock Exchange. The endogeneity problem is treated with the method of identification through heteroskedasticity as described by Rigobon and Sack (2004). The results suggest a significant impact on the exchange rate in one day i.e. an increase in the policy rate leads to an appreciation of the domestic currency, which is in line with the classic intuition. The effect increases markedly when the estimation is carried out with a two-day window suggesting the inefficiency of markets in incorporating monetary policy decisions in asset prices in a short period of time. Monetary policy affects spot yields positively, but the effect gradually dies out as the horizon gets longer. This can be explained with the impact on forward yields, as the results suggest a positive impact on short-term and a negative impact on long-term forward yields meaning that a surprise change in the policy rate leads to a rotation of the forward curve. The method does not provide interpretable and significant results for the stock exchange index.

JEL classification: E44, E52

Keywords: Monetary transmission mechanism, Asset prices, Exchange rate, Yieldcurve, Stock market, Identification, Heteroskedasticity