The study: The Eurodollar rate vs. currencies

To test this hypothesis, the one-, two-, and five-day price moves in four currencies (vs. the U.S. dollar) were analyzed respective to short-term U.S. interest-rate “shocks.”

The short-term interest rate was represented by the three-month Eurodollar (ED3) rate (as maintained by the Federal Reserve and converted into a price index). The four currencies were the same from last month’s article: the Canadian dollar (CAD), British pound (GBP), Japanese yen(JPY), and the Deutsche mark, both as an independent currency and as part of the euro (EUR). The analysis period spanned January 1973 to present, using daily data.

Each market was converted into daily returns and mapped against the sorted ED3 returns. Since January 1973, the ED3 has had average daily returns of 0.000014 percent, plus or minus a standard deviation of 0.04167 percent, which means the 95-percent confidence band lies at daily returns of 0.081687 percent and -0.081660 percent. These thresholds are the green vertical lines. The focus will be on the two, 2.5-percent slices of large down and up days to the left and right of these boundaries rather than the large section between them, which contains 95 percent of the observations.

There were 204 large ED3 down days and 238 large up days in the sample. This was somewhat surprising given the natural skittishness of the interest-rate market; we might have expected a skew toward large down days.

Three comparisons of currency returns on the extreme days will be made: those for the same day of an ED3 shock, those for the same day plus the next day, and those for the following week. The latter two comparisons are made to see how interest rate shocks are absorbed over time in the currency markets.