Exchange rate predictability. monetary policy announcements, and the term structure of interest rates

This thesis consists of five key chapters. The first two correspond to papers on exchange rate predictability (Chapters 2 and 3), and the next three focus on the effect of monetary policy announcements on the Australian term structure of interest rates (Chapters 4, 5, and 6). Chapter 2 estimates the Uncovered Interest Parity condition (UIP) for Australia using the Generalized Method of Moments (GMM) methods. Until recently, estimates of UIP used Ordinary Least Squares (OLS) methods to estimate the correlation However, in the presence of an omitted risk premium, the OLS estimate of the slope coefficient in the relationship will be biased and inconsistent. This chapter instead employs the GMM methods that relate the risk premium to the underlying economic variables to overcome the problem of omitted variables. After accounting for the unobservable risk premium, the slope coefficients are closer to their theoretical value of one. In addition, the GMM estimated equations perform better than the random walk and the OLS estimated equations in forecasting the exchange rate over short horizons. Chapter 3 undertakes an empirical investigation of information implied in the relative term structure of interest rates on the United States dollar (USD)/Australian dollar (USD/AUD) exchange rate. We interpret the information on macroeconomic fundamentals behind the relative factors of yield curve to account for predictable exchange rate changes. Our results show that the slope and curvature factors of the Australian yield curve relative to the US one can predict the USD/AUD exchange rate movements and excess returns on the AUD from one month to two years ahead. Moreover, our model performs better than the random walk in forecasting the USD/AUD exchange rate at horizons longer than 12 months. Chapter 4 investigates the effect of the target cash rate announcements on the term structure of interest rates in Australia using daily data. We find that unanticipated changes in the cash rate target significantly impact the entire term structure of interest rates, with the impact becoming smaller for longer maturities. We also compare volatilities across the term structure of interest rates on policy and non-policy announcement days and again find that the impact of monetary policy announcements on interest rate declines with maturity. More specifically, short-term interest rate volatility rises more than triple in the policy days while in the long-term, interest rate volatilities are more or less the same as those for non-policy days. Chapter 5 narrows the windows around Australian monetary policy announcements by employing intra-day data to mitigate the effect of other news on market interest rates on the announcement days. This method allows for a more precise evaluation of the impact of monetary policy announcements on the term structure of interest rates. Our results from intraday data show the Reserve Bank of Australia (RBA) announcements have significant impacts on the Australian term structure of Treasury bond yields that decline as the term to maturity increases. In addition, the adjustments of Treasury bond yields to the announcements are almost finished only 30 minutes after the announcement. Chapter 6 investigates whether monetary policy announcements result in jumps in the term structure of Australian Treasury bond yields. Using intraday data on the Australian Treasury bonds yields provided by the Securities Industry Research Centre of Asia-Pacific (SIRCA) for the period from January 1996 to December 2012, we find significant evidence of jumps across the term structure of Australian Treasury bond yields on the days of the release of the monetary policy decision by the RBA. The surprise component in the monetary announcement generates a surge in Treasury bond returns.