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Short-term determinants of bilateral exchange rates: A decomposition model for the Swiss franc

Author

Listed:
  • Fabian Fink
  • Lukas Frei
  • Oliver Gloede

Abstract

This paper develops an FX factor model to decompose short-term bilateral exchange rate dynamics into different global factors and local uniqueness. We apply the model to the Swiss franc exchange rates against the US dollar (USDCHF) and the euro (EURCHF) between 2006 and 2018 and decompose daily dynamics into three global factors: risk, US dollar, and euro. The model captures daily dynamics well, explaining approximately 73% of the variation in USDCHF and 37% of the variation in EURCHF. The risk factor contributes the most to Swiss franc dynamics, especially in times of a worsening risk environment, highlighting the role of the Swiss franc as a safe-haven currency. Global FX factors had been almost completely reflected in USDCHF dynamics before the euro area debt crisis, but once that crisis began, they also became important for EURCHF. Furthermore, momentum is present in daily Swiss franc returns, especially before the introduction of the EURCHF minimum exchange rate.

Suggested Citation

  • Fabian Fink & Lukas Frei & Oliver Gloede, 2020. "Short-term determinants of bilateral exchange rates: A decomposition model for the Swiss franc," Working Papers 2020-21, Swiss National Bank.
    • Handle: RePEc:snb:snbwpa:2020-21
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    File URL: https://www.snb.ch/en/publications/research/working-papers/2020/working_paper_2020_21
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    More about this item

    Keywords

    Factor model; variance decomposition; safe haven; carry trade; momentum;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis

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