Impact of Macroeconomic Announcements on Foreign Exchange Volatility: Evidence from South Africa

• Published date: 01 September 2017
• Author: Paul Alagidede,Tseke Maserumule
• DOI: http://doi.org/10.1111/saje.12160
• Date: 01 September 2017

IMPACT OF MACROECONOMIC ANNOUNCEMENTS ON

FOREIGN EXCHANGE VOLATILITY: EVIDENCE FROM

SOUTH AFRICA

TSEKE MASERUMULE AND PAUL ALAGIDEDE*

Abstract

This study focuses on scheduled macroeconomic news announcements and evaluates their impact

on the volatility of the South African rand (ZAR) and US dollar (USD) exchange rate using

high frequency data. The following asymmetries are studied: news items by geographical location,

no-news vs. surprise news announcements and positive vs. negative news announcements. We

make the following findings in our empirical study: (i) After the release of a news announcement,

the level of foreign exchange volatility rises. This is independent of whether the news item sur-

prised the market or not. (ii) Both South African and US news items significantly impact USD/

ZAR volatility, suggesting that the news items are being used to formulate investor expectations

regarding the future prospects of the currency pair. (iii) Negative news appears to have a greater

impact on exchange rate volatility relative to positive news. This result is also state dependent, as

investors tend to behave differently to news depending on the economic climate at that point in

time. Investor cognitive biases give rise to the asymmetric news effects on exchange rate volatility.

Finally, investors do not always act in rational manner, especially when faced with multiple news

items that are contradictory to each other.

JEL Classification: C1, G0, F0

Keywords: Exchange rates, macroeconomic news, high frequency data, market efficiency

1. INTRODUCTION

Financial economists have spent a considerable amount of time during the past few deca-

des trying to understand how information is incorporated into asset prices, especially in

the foreign exchange market. Currencies are the most actively traded financial assets rela-

tive to equities and bonds, with trading activity amounting to US$5.3 trillion per day in

April 2013 (Bank for International Settlements, 2013). A significant amount of literature

studying exchange rate determination focuses on how the arrival of new information

regarding the current state or future prospects of the economy affects exchange rates.

This is partly attributed to the fact that the foreign exchange market is highly integrated

with the macroeconomic fundamentals of an economy, resulting in exchange rates being

mostly driven by the macroeconomic fundamentals and monetary policies of a coun-

try(Li, Wong, & Cenev, 2015).

* Corresponding author: Professor, University of the Witwatersrand South Africa. E-mail:

paul.alagidede@wits.ac.za

We Acknowledge Research Funding from the Economic Research Southern Africa (ERSA) in

Conducting this Research. The Usual Caveat Applies.

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South African Journal

of Economics

Macroeconomic data has been widely used to test for informational efficiency in the

foreign exchange market. Empirical literature examining the effects of macroeconomic

news on exchange rates agree that macroeconomic news significantly affect exchange rates

often resulting in a jump in the exchange rate level and a rise in volatility(Laakkonen,

2009). Since the acceptance of this hypothesis in modern day exchange rate literature,

academic focus has shifted to examining the asymmetric effects of news on the exchange

rate level and volatility. There is ample literature that evaluates the effects of macroeco-

nomic announcements on exchange rates (see Anderson et al., 2003; Ehrmann and

Fratzscher, 2005; Fatum and Scholnick, 2008). While a great deal of the literature exam-

ines the macroeconomic and monetary factors that drive exchange rates (see Meese and

Rogof, 1983; Dornbusch, 1986; Engle and West, 2005; Ehrmann and Fratzscher, 2005;

Fatum and Scholnick, 2008; Krugman and Obstfeld, 2011), recent studies have focussed

on the market microstructure, particularly, on the imbalances between buy- and seller-

initiated trades in the foreign exchange market. The vast majority of these studies (Rime,

2000; Bauwens et al., 2003; Evans and Lyons, 2005, 2008; Vitale, 2007; Neely and Dey,

2010; Vega et al., 2015) analyse the transmission link between fundamental information

and exchange rates and dealer perceptions regarding the economic prospects on the

respective countries in the currency pair. Although sufficient strides have been made to

cover the first camp, very few studies analyse how news asymmetrically affects exchange

rate volatility, especially for emerging market currencies. While researchers such as Li

et al. (2015), Joo et al. (2009) and Fedderke and Flamand (2005) have conducted studies

on emerging markets currencies, their focus has been on the directional moves in the cur-

rency as opposed to its volatility. Moreover, the extant literature analyses exchange rates

from the point of view of daily data with little or no inference to the differential impact

of news on exchange rates. This study fills these gaps in the literature regarding the analy-

sis of macroeconomic news on exchange rate volatility in South Africa. The use of high

frequency data rather than daily data improves our understanding of the dynamic prop-

erties and drivers of volatility of the USD/ZAR as the impact of the news announcement

can be pinpointed. The study also assesses the presence of any asymmetric behaviour in

the USD/ZAR currency pair to the arrival of macroeconomic news. The investigation

focuses on how the exchange rate volatility reacts to the following variables: (i) domestic

and international macroeconomic data (ii) surprise and no-news announcements (iii)

positive and negative surprises. Given the changes in the microstructure of the foreign

exchange market since the 2008 Global Financial Crisis, and the extreme swings in the

South African rand against major international currencies in recent times, the study pro-

vides an updated report of the work done by Fedderke and Flamand (2005). However, it

extends on work done by Fedderke and Flamand (2005) by studying the effects on the

exchange rate volatility and the efficiency of the foreign exchange market in South Africa.

The use of high frequency data instead of closing prices also provides an added advantage

of focusing only on the exact news item and its market impact.

The results of this study will provide guidance to foreign exchange market participants

who trade USD/ZAR derivatives and asset managers who include currency derivatives in

their portfolios to hedge their currency risk. Volatility is a key input in derivative pricing

under Black-Scholes option pricing framework and understanding this subject matter will

allow participants to make better informed decisions when trading such securities. It will

also allow for improved risk management by derivative traders, attributable to a better

understanding of the potential effects of macroeconomic news on the underlying volatility.

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