NBER WORKING PAPER SERIES
MICRO EFFECTS OF MACRO ANNOUNCEMENTS:
REAL-TIME PRICE DISCOVERY IN FOREIGN EXCHANGE
Torben G. Andersen
Tim Bollerslev
Francis X. Diebold
Clara Vega
Working Paper 8959
http://www.nber.org/papers/w8959
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
May 2002
This work was supported by the National Science Foundation and the Wharton Financial Institutions Center. We are
grateful to Olsen and Associates for making available their real-time exchange rate quotations data, and to Money Market
Services International for making available their news announcement expectations data. For useful comments we thank
the Editor and three referees, as well as Ricardo Cabellero, Dean Croushore, Kathryn Dominguez, Bernard Dumas,
Martin Evans, Michael Fleming, Jeff Frankel, Linda Goldberg, Ken Kavajecz, Rich Lyons, Nelson Mark, Frank
Schorfheide, Nick Souleles, Allan Timmermann, Mark Watson, Ingrid Werner, and Jonathan Wright, and participants
at the CAF Conference in Denmark on Market Microstructure and High-Frequency Data in Finance, the University of
Wisconsin Conference on Empirical Models of Exchange Rates, the Federal Reserve Bank of Philadelphia Conference
on Real-Time Data Analysis, the NBER International Finance and Macroeconomics Program Meeting, and seminars at
the University of Pennsylvania and the University of Houston. The views expressed herein are those of the authors and
not necessarily those of the National Bureau of Economic Research.
© 2002 by Torben G. Andersen, Tim Bollerslev, Francis X. Diebold and Clara Vega. All rights reserved. Short sections
of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including ©
notice, is given to the source.
Micro Effects of Macro Announcements:
Real-Time Price Discovery in Foreign Exchange
Torben G. Andersen, Tim Bollerslev, Francis X. Diebold and Clara Vega
NBER Working Paper No. 8959
May 2002
JEL No. F3, G1
ABSTRACT
Using a new dataset consisting of six years of real-time exchange rate quotations, macroeconomic
expectations, and macroeconomic realizations (announcements), we characterize the conditional means
of U.S. dollar spot exchange rates versus German Mark, British Pound, Japanese Yen, Swiss Franc, and
the Euro. In particular, we find that announcement surprises (that is, divergences between expectations
and realizations, or “news”) produce conditional mean jumps; hence high-frequency exchange rate
dynamics are linked to fundamentals. The details of the linkage are intriguing and include announcement
timing and sign effects. The sign effect refers to the fact that the market reacts to news in an asymmetric
fashion: bad news has greater impact than good news, which we relate to recent theoretical work on
information processing and price discovery.
Torben G. Andersen Tim Bollerslev
Department of Finance Departments of Economics and Finance
Kellogg School Duke University
Northwestern University and NBER
and NBER boller@econ.duke.edu
t-andersen@kellogg.nwu.edu
Francis X. Diebold Clara Vega
Departments of Economics, Finance and Statistics Graduate Group in Economics
University of Pennsylvania University of Pennsylvania
and NBER cvega@ssc.upenn.edu
fdiebold@sas.upenn.edu
1
The classic statement is of course Meese and Rogoff (1983). For a good survey of the subsequent empirical
exchange rate literature through the early 1990s, see Frankel and Rose (1995). In later work, Mark (1995) and
Mark and Sul (1998) find that fundamentals matter in the long run but not in the short run. Evans and Lyons (2002)
find that order flow matters in the short run but fail to link order flow to fundamentals.
1. Introduction
How is news about fundamentals incorporated into asset prices? The topic confronted by this
question – characterization of the price discovery process – is of basic importance to all of financial
economics. Unfortunately, it is also one of the least well understood issues. Indeed, some influential
empirical studies have gone so far as to suggest that for some assets – notably foreign exchange – prices
and fundamentals are largely disconnected.
1
In this paper we provide an empirical examination of price discovery in the challenging context
of foreign exchange. Using a newly-constructed dataset consisting of six years of real-time exchange rate
quotations, macroeconomic expectations, and macroeconomic realizations (announcements), we
characterize the conditional means of U.S. dollar spot exchange rates for German Mark, British Pound,
Japanese Yen, Swiss Franc and the Euro. In particular, we show that announcement surprises (that is, the
difference between expectations and realizations, or “news”) produce conditional mean jumps, and we
provide a detailed analysis of the speed and pattern of adjustment.
We show that conditional mean adjustments of exchange rates to news occur quickly, effectively
amounting to “jumps,” in contrast to conditional variance adjustments, which are much more gradual, and
that an announcement’s impact depends on its timing relative to other related announcements, and on
whether the announcement time is known in advance. We find, moreover, that the adjustment response
pattern is characterized by a sign effect: bad news has greater impact than good news. Finally, we relate
our results to recent theoretical and empirical work on asset return volatility and its association with
information processing and price discovery.
The paper relates to earlier work in intriguing ways, but at least three features differentiate our
findings from previous results along important dimensions. These include our focus on foreign exchange
markets, our focus on conditional mean as opposed to conditional variance dynamics, and the length and
breadth of our sample of exchange rate and announcement data. Let us discuss them briefly in turn.
First, we focus on foreign exchange markets as opposed to stock or bond markets, and we address
the central open issue in exchange rate economics – the link between exchange rates and fundamentals. It
is comforting, however, that a number of recent papers focusing largely on bond markets reach
conclusions similar to ours. Balduzzi, Elton and Green (2001), for example, examine the effects of
economic news on prices in the U.S. inter-dealer government bond market, finding strong news effects
2
Also, in concurrent related work for T-bond futures, Hautsch and Hess (2001) report highly significant, but short-
lived, price and volatility impacts in response to new and revised employment figures.
-2-
and quick incorporation of news into bond prices, while Fleming and Remolona (1997, 1999) show that
the largest bond price movements stem from the arrival of news announcements.
2
Second, we focus primarily on exchange rate conditional means as opposed to conditional
variances. That is, we focus primarily on the determination of exchange rates themselves, as opposed to
their volatility. We maintain this focus both because the conditional mean is of intrinsic interest, and
because high-frequency discrete-time volatility cannot be extracted accurately unless the conditional
mean is modeled adequately. Hence our work differs in important respects from that of Andersen and
Bollerslev (1998), Bollerslev, Cai and Song (2000), Ederington and Lee (1993), and Payne (1996), for
example, who examine calendar and news effects in high-frequency asset return volatility but do not
consider the effects of news on returns themselves.
Third, we use a new dataset which span a comparatively long time period, and include a broad set
of exchange rates and macroeconomic indicators.
Notwithstanding the improvements obtained through the above consideration, our results are
quite consistent with prior related work. Indeed, several studies have linked macroeconomic news
announcements to jumps in exchange rates, and our findings may be viewed as providing confirmation
and elaboration. Goodhart, Hall, Henry, and Pesaran (1993), for example, examine one year of high-
frequency Dollar/Pound exchange rates and two specific news events – a U.S. trade figure announcement
and a U.K. interest rate change – and conclude in each case that the news caused an exchange rate jump.
Similarly, Almeida, Goodhart and Payne (1998) in their study of three years of high-frequency
DM/Dollar exchange rates and a larger set of news announcements, document systematic short-lived
news effects. Finally, Dominguez (1999) argues that most large exchange rate changes occur within 10
seconds of a macroeconomic news announcement, and that close timing of central bank interventions to
news announcements increases their effectiveness.
We proceed as follows. In section 2 we describe our high-frequency exchange rate and
macroeconomic expectations and announcements data. In section 3 we characterize the speed and pattern
of exchange rate adjustment to macroeconomic news, and we document, among other things, the sign
effects (i.e., a larger exchange rate response to bad than good news). In section 4 we relate the sign
effects to recent theories of information processing and price discovery. We conclude in section 5.
2. Real-Time Exchange Rates, Expected Fundamentals, and Announced Fundamentals
-3-
Throughout the paper we use data on exchange rate returns in conjunction with data on
expectations and announcements of macroeconomic fundamentals. The data are novel in several respects,
such as the simultaneous high frequency and long calendar span of the exchange rate returns, as well as
the real-time nature of the expectations and announcements of fundamentals. Here we describe them in
some detail.
Exchange Rate Data
The raw 5-minute CHF/$, DM/$, Euro/$, Pound/$ and Yen/$ return series were obtained from
Olsen and Associates. The full sample consists of continuously-recorded 5-minute returns from January
3, 1992 through December 30, 1998, or 2,189 days, for a total of 2,189·288 = 630,432 high-frequency
foreign exchange (FX) return observations. As in Müller et al. (1990) and Dacorogna et al. (1993), we
use all of the interbank quotes that appeared on the Reuters screen during the sample period to construct
our 5-minute returns. Each quote consists of a bid and an ask price together with a “time stamp” to the
nearest second. After filtering the data for outliers and other anomalies, we obtain the average log price at
each 5-minute mark by linearly interpolating the average of the log bid and the log ask at the two closest
ticks. We then construct continuously-compounded returns as the change in these 5-minute average log
bid and ask prices. Goodhart, Ito and Payne (1996) and Danielsson and Payne (1999) find that the basic
characteristics of 5-minute FX returns constructed from quotes closely match those calculated from
transactions prices (which are not generally available for the foreign exchange market).
It is well known that the activity in the foreign exchange market slows decidedly during
weekends and certain holiday non-trading periods; see Müller et al. (1990). Hence, as is standard in the
literature, we explicitly excluded a number of days from the raw 5-minute return series. Whenever we
did so, we always cut from 21:05
GMT the night before to 21:00
GMT that evening. This particular
definition of a “day” was motivated by the ebb and flow in the daily FX activity patterns documented in
Bollerslev and Domowitz (1993) and keeps the daily periodicity intact. In addition to the thin weekend
trading period from Friday 21:05
GMT until Sunday 21:00
GMT, we removed several fixed holidays,
including Christmas (December 24 - 26), New Year’s (December 31 - January 2), and July Fourth. We
also cut the moving holidays of Good Friday, Easter Monday, Memorial Day, July Fourth (when it falls
officially on July 3), and Labor Day, as well as Thanksgiving and the day after. Although our cuts do not
account for all of the holiday market slowdowns, they capture the most important daily calendar effects.
Finally, we deleted some of the returns contaminated by brief lapses in the Reuters data feed.
This problem, which occurs almost exclusively during the earliest part of the sample, manifests itself as
sequences of zero or constant 5-minute returns in places where missing quotes had been interpolated. To
