Exchange rates and news

This paper investigates the role of news on exchange rate determination. First different structural models, including monetary and portfolio balance models, and their empirical validity are briefly surveyed. Next, approaches modelling the so called news effect on exchange rates are evaluated, and, finally, the news effect on the DEM/USD, DEM/GBP and GBP/USD exchange rates is empirically tested. Within the context of a monetary model Frenkel (1981) has tested the ·news effect by regressing spot rate on forward rate and unexpected interest rate differential derived by instrumental variable method. In our test the term structure of interest rates is used to derive the unexpected interest rate differential, and some support for the news effect is obtained.