TRADE ANNOUNCEMENTS, EXCHANGE RATES, AND INTEREST RATES

KEIVAN DERAVI, PHILIP GREGOROWICZ, CHARLES E. HEGJI

ABSTRACT
This paper demonstrates a significant depreciation of the dollar in foreign exchange markets to announcements of larger than anticipated monthly U.S. trade deficits over the entire period from early 1985 through late 1988 but differential interest rate responses to this information. Through mid 1986 short term interest rates declined on the announcement of negative trade news which is consistent with monetary easing to depreciate the dollar during this time period so as to narrow the trade gap. For trade announcement surprises after this, through late 1988, interest rates increased across the entire maturity structure. This result suggests a policy reversal by the central bank in response to continued large trade deficit announcements in order to defend the foreign exchange value of the dollar. Yet the continued depreciation of the dollar coupled with rising long term interest rates are consistent with increased risk premia associated with holding dollar denominated assets during this time period. *Direct all correspondence to: Philip Gregorowicz, Department of Economics, Auburn University at Montgomery, Montgomery AL 36117-3596. Keivan Deravi and Charles E. Hegji, Auburn University. International Review of Economies and Finance, l(l):@-101 Copyright 8 1992 by JAI Press, Inc. ISSN: 1059-0%0 AlI rights of reproduction in any form reserved.
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89

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KEVIAN DERAVI, PHILIP GREGOROWICZ,

and CHARLES HEGJI

I. INTRODUCTION
Numerous studies have found a link between movements in exchange rates or interest rates and macroeconomic announcements (Cornell, 1982, 1983a,b; Culbertson and Koray, 1986; Dornbush, 1980; Edwards, 1982; Engel and Frankel, 1984; Frenkel, 1981; Gavin and Karamouzis, 1986; Hakkio and Pearce, 1985). These studies have clearly established that such macroeconomic announcements provide information to market participants useful for forming expectations. Recently, studies of news have shifted toward the international sector, given policy concern with a highly unstable foreign-exchange value of the dollar and persistently large U.S. trade deficits. Studies by Hardouvelis (1988) and Deravi et al. (1988) have examined financial market response to U.S. balance of trade announcements. These results, however, have been mixed. Hardouvelis measures the response of three interest rates and seven exchange rates to economicnews on several macroeconomicvariables, including the U.S. balance of trade over the October 1979 to August 1984 period. He finds market response to U.S. trade announcements insignificant over this period. Deravi et al. confirm these findings for the subsample February 1980 to February 1985, but show significant foreign exchange response to U.S. balance of trade announcements over the period March 1985 to July 1987. The present paper extends these two studies. This paper augments Deravi et al. by examining short- and long-term interest rate response to U.S. balance of trade announcements as well as movements in foreign exchange rates. In addition, this paper examines a longer sample period than Hardouvelis. By considering the response of both interest rates and exchange rates over this sample period, the paper enables us to address some questions unanswered by these earlier studies. In particular, we deal with market perceptions about the growing monthly trade deficits, and with the monetary policy response to these deficits, if any, over this period. During the 1985 to 1988 period policy-makers are believed to have adapted money supply targets to conditions in the international financial markets. It is widely believed that from early 1985 to 1986, a significant effort to depreciate the dollar and close the U.S. trade gap was undertaken by the Federal Reserve in conjunction with the Group of Five. By 1987, despite a significantly lower dollar, the U.S. was still generating sizeable trade deficits and had become a net debtor nation. As a result, throughout 1987 the perception was that monetary policy had changed, and was aimed at stabilizing the dollar. This suggests that the informational content in monthly trade deficit announcements and market responses to these announcements vary over time. By examining interest rate response as well as foreign exchange response to the trade announcements, we can draw some tentative conclusions about market perceptions concerning the Federal Reserves response to this information and other financial market concerns. The paper is organized as follows. Part II of the paper presents our empirical framework for studying the response in exchange rates to the balance of trade an-

Trade Announcements, Exchange and Interest Rates

91

nouncement. The data are discussed in Part III. Part IV presents our empirical results. Six dollar foreign exchange rates, the 90day and one-year Treasury Bill rates, five-year Treasury note rates, and fifteen-year Treasury Bond rates are regressed against the anticipated and unanticipated components of the U.S. monthly balance of merchandise trade announcement. In general, we find a significant exchange rate response to the balance of trade announcement for the period 1985.03 to 1988.07, with a larger than expected trade deficit leading to a depreciation of the dollar against most foreign currencies. This result confirms the earlier findings of Deravi et al. (1988) that demonstrate a significant foreign exchange market response during the post-1985 period of widening U.S. balance of trade deficits. In addition, we also find evidence that short-term interest rates responded to the unexpected component of trade deficit announcements over this period, with the response differing by subsamples. Over the period 1985.03 to 1986.07, both the 90-day and the one-year Treasury Bill rates significantly decreased in response to a larger-thananticipated announcement of the U.S. trade deficit. This decline in short-term interest rates is consistent with an immediate policy response to the trade announcement or with a perceived liquidity effect associated with monetary expansions. However, over the period 1986.08 to 1988.07, short-term interest rates increased with the announcement of a larger than anticipated trade deficit. This finding is consistent with markets interpreting the announcement as a signal of future monetary tightening to defend the value of the dollar. The dollar was seen to significantly depreciate in response to the trade deficit However, this depreciation announcement over the 1985.3 to 1986.7 subsample. continued into the 1986-1988 period. This suggests that other market factors besides the perception of monetary policy governed the dollars response to the trade announcement over the post-1986 period, one of these factors being the increased risk associated with holding dollar denominated assets. Long-term interest rates were seen to rise significantly in response to the unanticipated trade announcements, but only over the over the 1986.8 to 1988.7 subsample. This finding suggests that long term interest rates may not reflect market perceptions about the current monetary stance toward the dollar, but also suggests that other factors such as risk premia may have governed the behavior of the long-term rate over the latter period. These conclusions are briefly discussed in Part V.

II.

FRAMEWORK FOR TESTING ASSET PRICE MOVEMENTS TREASURY BALANCE OF TRADE ANNOUNCEMENTS

AND

Changes in exchange rates or interest rates as a function of the Department of Commerces monthly announcements of the balance of payments of merchandise trade can be specified in the following form:

92

KEVIAN DERAVI, PHILIP GREGOROWICZ,

and CHARLES

HEGJI

where APt = the change in the spot exchange rate or interest rate at time t - log Pt - log P,_l E& = the size of the trade announcement at time t = log &L) U& = the size of the unexpected trade announcement at time t = log (A,) - EN, At = the actual size of the debt announcement at time t et = the random error Equation 1 is used for testing the joint hypotheses of responsiveness of financial asset prices to the Departments announcement and market efficiency. Aside from a constant and random error term, the effect of the trade announcement on the asset price movement is decomposed into its expected and unexpected components. As Leroy (1982) has suggested, such a decomposition can be used to test for market efficiency when traders in the market are equally-informed and risk neutral. Under these conditions, if markets are efficient, the expected announcement should have no effect on asset prices. That is, the parameter LQ = 0, and only the coefficient of the unexpected parameter, b, should have a significant systematic effect on asset prices. We hypothesize that the value of bs depends on Federal Reserve response to the trade announcement or market expectations about monetary policy triggered by this new information. The value will also depend on which asset price we are considering. To see this, consider a sticky-price model with perfectly efficient markets. Also, assume all variables influencing the exchange rate are held constant except the money supply and a shock to the trade account. Three scenarios with respect to Federal Reserve response to an unanticipated trade deficit emerge from this set-up. First, if the Fed responds to an unanticipated trade announcement by expanding the money supply, the dollar should depreciate, short-term interest rates should fall (temporary liquidity effect), and long-term interest rates might rise (anticipated inflation effect). In this case, bs will be positive for the long-term interest rate and exchange rate equations, and negative for the short-term interest rate equations. Second, if the Federal Reserve responds to an anticipated trade deficit announcement by decreasing the monetary growth rate, the dollar may appreciate (or at least not depreciate as significantly), short-term interest ratesshouldrise (again a liquidity effect), and long-term interest rates might fall due to a reduction in the anticipatedinflation rate. In this case, b3 will be negative for the long-term interest rate and exchange rate equations, and positive for the short-term interest rate equations. Finally, if the Federal Reserve does not respond to the trade deficit, no financial market effects might result. In this instance, Zr3 will be zero for all asset response equations.

Trade Announcements,

Exchange and Interest Rates

93

III.

THE DATA

The empirical analysis of this study is based on the monthly merchandise trade announcements issued by the U.S. Department of Commerce for the period beginning in February 1980 and ending with the trade announcement for July 1988. Since March of 1988 each trade announcement reflected the monthly trade balance two months prior to that announcement. Prior to March of 1987 the delay was only one month. Each of these announcements includes only U.S. merchandise trade and excludes the other components in the current account such as transfers and trade in services. Since the United States ran a continuous trade deficit over this entire sample period, these trade deficits were treated as positive values. It should be mentioned that the trade announcements in our sample were made on no one particular day of the week, but rather were randomly distributed throughout the week. This means that the exchange rate and interest rate responses to the trade announcements were not due to a spurious correlation with money supply announcements. The expected announcement series EA, was based on the expected monthly trade balance provided by Money Market Service, Inc. This expectation series is the median trade estimate of approximately 60 economists surveyed by Money Market Services, Inc. Although no study of the efficiency of this particular expectation series exists, its use is preferred to alternative expectations series, such as a series based on an ARIMA forecasting procedure. Engle and Frankel (1984) have demonstrated that for the monetary expectations series, the Money Market expectations data are unbiased predictors of actual announcements. For other expectations series it has been shown by Pearce and Roley (1985) and Hardouvelis (1988) that these survey forecasts, while not always unbiased and efficient, have smaller root mean square errors than alternative forecasts. The exchange rate and interest rate data used in this study were obtained from various issues of the Wall Street Journal. For both the six exchange rates and the four interest rates used in this study, the representative closing prices on the day preceding the announcement were used as the before announcement spot prices and the closing prices on the day of the monthly trade announcement were used as the after-announcement exchange rates and interest rates. The spot exchange rates are the prices of foreign currencies in terms of U.S. dollars. The four interest rates used were the annualized yields to maturity, expressed in percentages. The 90-day and one-year Treasury bill yields, five-year Treasury note and fifteen-year Treasury bond yields were used to be representative of the yield curve response to trade announcements.

IV.

EMPIRICAL RESULTS

The estimated responses of the six exchange rates and four interest rates to the monthly trade balance announcements are presented in Tables 1 through 4. The results indicate

94

KEVIAN DERAVI, PHILIP GREGOROWICZ,

and CHARLES

HEGJI

Table I.

Exchange Rate Response to the Monthly Merchandise Trade Announcement (1985.3 to 1988.7)
Britishpound Canadian dollar -0.0002 (0.3976) -0.0035 (0.9104) 0.0026 (0.9010) 0.0362 1.8126

French franc West German mark Japanese yen Swissfianc

-0.0017 (1.1076) -0.0120 (0.9236) 0.0479 (4.9945) 0.3966 1.7971 -0.0013 (0.9738) -0.0003 (0.0258) 0.0472* (5.7217) 0.4682 2.2a84 0.0012 (0.4980) -0.0209 (1.0868) 0.0508* (3.5688) 0.2555 2.1665 AI.0018 (1.0688) -0.0054 (0.0572) 0.0.572* (5.6277) 0.4562 2.1583

Constant

-0.0016 (1.0613)

EA,

0.0028 (0.2206)

UA,

0.0409. (4.3425)

R2 D.W. Note:

0.3408 2.2402

&statistics in parentheses. *indicates parameter significant at 1% level.

that the market responses in exchange rates and interest rates to the news implicit in these announcements are conditioned by the sample period chosen. Table 1 shows our exchange rate responses to the monthly trade deficit announcements for the period 1985.3 to 1988.7. Table 2 provides the interest rate responses for the period 1980.2 to 1985.2 and for the period 1985.3 to 1988.7. In Table 3 the interest rate responses for two separate sub-periods for the last time period are provided, while the exchange rate responses for these sub-periods are contained in Table 4. It has been demonstrated by Deravi et al. (1988) that significantly different exchange rate responses to monthly trade deficits are obtained over separate segments of the post-1980 sample period. The justification for segmentation of the 1980 sample into two separate periods was on the basis of the differential news implicit in monthly trade announcements. This news is conditioned by both the magnitude of the trade deficit announcements and the Federal Reserve response to these announcements. For the earlier period between 1980.2 and 1985.2 monthly trade deficit announcements averaged $5.69 billion. After that the mean value of the monthly trade deficit announcement increased to $13.64 billion. Consistent with the changing magnitude of the trade deficit, Humpage (1988) and Furlong (1989) indicate a shift in both the Federal Reserves and the Treasurys attitudes towards exchange rates over this period. Humpage suggests that while there was no coordinated effort to depreciate the dollar prior to the Group of five (G5) meetings in September of 1985, large direct intervention by foreign central banks and the Federal Reserve to depreciate the dollar against the key major currencies occurred in early 1985. Moreover, Furlong notes that consistent with this objective, there was a marked increase in the relative ranking of exchange rates as policy variables mentioned in the FOMC Policy Directives beginning in March 1985. Deravi et al. (1988) indicate that prior to 1985.3 exchange rates did not significantly respond to trade announcements. After that date they found a significant depreciation

Trade Announcements, Exchange and Interest Rates

95

Table 2.

Interest Rate Responses to Monthly Merchandise Trade Announcements (1980.2 to 1988.7)

1980.2 to 1985.2 1985.03to 1988.07 1sYr. 0.0031* (2.5303) -0.0029 90-Den, -0.0016 (0.5100) 0.0113 (0.4430) xmO37 (0.1940) 0.0056 1.9397 I-Yr. -0.0014 (0.7189) AmOO (0.0198) -0.OlCH3 (0.8%7) 0.0213 1.8813 Si-Yr. -0.0007 (0.3460) -4mO70 (0.4025) 0.0169 (1.3045) 0.0439 2.2659 15-Yr. -0.0002 (0.0950) 0.0071 (0.3647 0.0226 (1.5585 0.0686 2.2313

9Odw

TB

I-Yr. 0.0015 (1.0388) 0.0024 (0.5604) 4moo2 (0.0707) 0.0055 2.4700

S-Yr. 0.0006 (0.3704) -0.twO2 (0.0328) -0.0021 (0.6620) 0.0085 2.0005

cmstant

-0.ooo9 (0.2740)

EA,

0.0044
(0.4810)

to.=m
-0.0002 (0.0767) 0.0135 2.2894

UA,

-0.0140* (2.2648)

R2 D.W. Note:

0.1016 1.9267

t-statistics parentheses. in *indicates parametersignificant at 5% level.

Table 3.

Interest Rate Responses to Monthly Merchandise Trade Announcements

lP85.3 to 1986.7 1986.8 to 1988.7 I5-Yr. -0.0006 (0.1280) 0.0406 (1.0824) 0.0115 (0.4434) 0.0948 1.8123 W-Day -0.m (0.1521) -0.0262 (0.8229) 0.0424** (1.6745) 0.1265 2.1274 1 -Yr. -BOO3 (0.1376) -0.0083 (0.4322) 0.0199 (1.2994) 0.0756 2.0836 5-Yr. -0.0001 (0.0391) -0.0298 (1.3466) 0.0287.. (1.6215) 0.1497 2.506 IS-Yr. 0.0009 (0.3084) -0.0137 (0.6135) 0.0355** (1.9963) 0.1609 2.447

Wday Constant 0.0014 (0.3638)

TB I-Yr. -1.0015 (0.5354) 0.0027 (0.1088) -0.0478f (2.8227) 0.3633 1.6188

5-Yr. -0.0004 (0.1110) 0.0313 (1.0976) 0.0061 (0.3106) 0.0893 2.234

EA,
-

O.M64** (2.0387) -0.0607* (2.7039)

UA,

R2 D.W. Note:

0.4300 1.6606

t-statistics parentheses. in *indicates parametersignificant at 5% level. **indicates parametersignificant at 10% level.

KEVIAN DERAVI, PHILIP GREGOROWICZ,

and CHARLES

HEGJI

of the dollar in response to the unanticipated component of the monthly merchandise trade announcement. We do not report the insignificant exchange responses for the earlier period 1980.3 to 1985.2; however, Table 1 provides the results if we extend the latter period to 1988.7. Our results indicate a significant depreciation of the dollar to the unexpected component of the trade announcement over the period 1985.3 to 1988.7. Five of the six currencies studied responded significantly to this information. The parameter estimates of the British pound, the French franc, the West German mark, the Swiss franc and the Japanese yen were all significant at the 1% level. The parameter estimates are larger then previously reported in Deravi et al. (1988) when this sample period is extended. In addition, the R* are substantially large compared to other announcement studies and indicate that on average almost 40% of the variation in the spot rate on the day of the trade deficit announcements is explained by the announcement. The response of four interest rates to the monthly trade announcements are provided in Tables 2 and 3 for different subsamples of the 1980.2 to 1988.7 period. Table 2 uses the segmentation of the data based on the exchange rate responses and estimates the interest rate response prior to early 1985 and after that date. Our results indicate that, for the most part, interest rates did not immediately respond to the monthly trade deficit announcements. Only the parameter estimate for the 90-day Treasury bill in the earlier period is significant. This result for the earlier period is consistent with that of Hardouvelis (1988). He argues that if unanticipated increases in the trade deficit lead markets to anticipate further future increases in the trade deficits due to reduced exports, domestic interest rates should be depressed on announcement. For the latter period, 1985.3 to 1988.7, our empirical results do not reveal any significant short-term interest rate or long-term interest rate response to trade announcements. This lack of significant interest rate response is apparently inconsistent with the significant exchange rate response during this period. If the Federal Reserve was attempting to depreciate the dollar in foreign exchange markets in order to improve the U.S. trade balance, a decrease in domestic short-term interest rates would be expected as a response to a large monthly trade deficit announcement. However, to the extent that this anticipated monetary injection led to increased inflationary expectations, long-term interest rates would be expected to increase on announcement. More insight into the relationship between trade announcements, exchange rates, and interest rates, as indicators of monetary policy over the post 1985.2 period can be gained if this period is segmented into two sub-intervals. Table 3 provides the interest rate responses to the monthly trade deficit announcements for the period 1985.3 to 1986.7 and for the period 1986.8 to 1988.7. Table 4 provides the exchange rate response to the trade deficit announcements for these two periods. In part, this choice of subsamples was dictated by interest rate trends during this post 1985.2 period. Interest rates declined due to monetary policy objectives and bottomed out in late 1986. After that time, tightened monetary policy, real economic expansion, and rising inflation rates induced a general increasing trend to nominal interest rates. This choice of subsamples is also consistent with foreign exchange market behavior

Table 4.
t0

Exchange Rate Response to the Monthly Merchandise Trade Announcement

1988.7 Japanese Yen .OLM2 .aHM (.2727) -.m% (.5134) .0257** (4.2266) 4602 2.225 1.998 1.978 (.640(-J .0276 .5864 (5.4426) (1.9922) 2261 1.972 .0541* -.0016 .0664* (.5652) (.2581) (1.7582) 1.0811) .0637* (5.444) .5921 2.234 -.@I91 -BOO8 -.0269*** -.0012 (.9500) (.3333) (1.6842) (1.2222) -.ooo1 (.=) -AM28 (1.0071) .0278 (9456) .1112 2.1% -.0019 -.0032 Ym -.ooo2 Japanese
Swiss franc

1985.3 West Gemum mark .0015 (l.oooo) -.0020 (.1550) .0199** (2.2360) 2617 1.966 British Swiss franc pound CanaaTan dollar French franc West Gennan mark

1986.8 ma.7 t0

British

pound

Canadicm dollar

French franc

chlstan1

0.0001

-.ooo8

.0026

-.m

-SKI21 (.9545) -.0061

(.0417)

(.0800)

(1.1818)

EA,

.0216

-.0075

.0132

P52) -.oo%
(.5549) .0616* (4.4638) A871 2.148

(.9954)

(.8621)

(.7059)

VA,

.0227

0087

.0178

C3466) .@777* (5.5106) .5977 2.046

(1.6214)

(1.4500)

(1.3798)

R2

.2206

.1574

.1561

D.W.

2.141

1.754

1.510

Nofe: Matistics in parentheses. *indicates parameter significant 1% level. at **indicates parameter significant 5% level. al ***indicates parameter significant 10% level. at

KEVIAN DERAVI, PHILIP GREGOROWICZ,

and CHARLES

HEGJI

and the response of policy-makers to exchange rates. Coordinated attempts to depreciate the dollar in foreign exchange markets occurred throughout 1985 and ended in early 1986. Although world central bankers did not again intervene in foreign exchange markets until early 1987, the Group of Seven (G7) meetings in February of 1987 were in response to substantial depreciation of the dollar prior to this meeting. The stated aim after the meeting was to stabilize the dollar in foreign exchange markets. If this view of a policy change is correct, we should expect that the earlier attempts to depreciate the dollar will be associated with declines in short-term interest rates and increases in long-term rates on announcement, while later attempts at exchange rate stabilization will be associated with short-term interest rate increases and long-term interest rate reductions. To the extent that foreign exchange markets are dominated by policy expectations, a switch from a dollar depreciation on announcement to an appreciation (or smaller depreciation) would also be observed. As Tables 3 and 4 suggest, however, the results over the post-1985 period are only partly consistent with this view. In the earlier sub-period between 1985.3 and 1986.7, the parameter estimates of the unexpected components of the monthly trade deficit announcements show that short-term U.S. interest rates dropped in response to these announcements. Estimates of the surprise component of the announcement for the 90&y and the one-year Treasury notes are both significant at the 5% level. This is consistent with immediate policy adjustments to these surprises, or with market participants believing that deficit surprises would lead to future interest rate declines due to monetary interventions. In all cases the dollar responded accordingly and depreciated on announcement, with the response being significant at the 5% level for the Deutchmark and Swiss franc. However, neither the five-year Treasury note nor fifteen-year bond rates increased significantly on announcement. This suggests that, although markets may have perceived that trade deficits led to monetary injections over this subperiod, this perception did not heighten inflationary expectations. The findings for the 1986.8 to 1988.7 period are more puzzling. Table 3 shows that monthly deficit surprises led to interest rate increases over this subperiod. The parameter estimates of UA are all positive and significant at the 10% level for the 90-day Treasury bill rate, the rate on five-year notes and the fifteen-year Treasury bond rate. At the short end of the maturity structure, these results suggest a reversal in Federal Reserve response to monthly trade deficit announcements in an attempt to defend the foreign exchange value of the dollar. Alternatively, the results are consistent with market expectations of such monetary tightening. The short-term interest rate responses, therefore, support the hypothesis that market perceptions of monetary policy dominate asset price responses in foreign exchange markets. The significant increase in long-term interest rates to the monthly trade announcements, on the other hand, is not consistent with the decreased inflationary expectations that follow a monetary withdrawal. Moreover, as Table 4 shows, all currencies--with the exception of the Canadian dollar-continued to depreciate with the trade announcements during the 1986.8 to 1988.7 period. These responses were all

Trade Announcements, Exchange and Interest Rates

99

significant at the 1% level. These foreign exchange responses are, similarly, inconsistent with a monetary withdrawal. The results for the latter sub-interval suggest that although market perceptions of Federal Reserve policy may have played some role in determining asset price responses to trade announcements over this period, alternative factors dominated these responses. One such possible set of factors is related to the growth in the dollar-denominated assets in investors portfolios over the 1986.88 to 1988.07 period. By 1987, the United States, having generated large trade deficits for some time, had become a net debtor nation. As the stock of dollar-denominated assets in investors portfolios grew, increasingly large risk premia were demanded to hold these assets. Announcements of unexpectedly large trade deficits over this interval may have, therefore, added to these risk premia. Consequently, on news of an unanticipated increase in the U.S. trade deficit, the dollar depreciated and both short-term and long-term U.S. interest rates rose to accommodate the increased risk premia.*

V. CONCLUSIONS
In this paper we investigated the exchange rate and interest rate responses to the monthly merchandise trade announcements, focusing on the post-1985 period. We demonstrated a significant exchange rate depreciation to the announcement of a larger than expected trade deficit. This result contrasts with previously reported lack of exchange rate response prior to 1985. Second, interest rates did not respond to trade announcement surprises when the response was analyzed over the entire post-1985 period. However, for the trade announcements covering the 1985.3 to 1986.7 period, our analysis indicated a significant decrease in short-term interest rates to larger than anticipated trade deficit announcements. This result is consistent with the view that during this period the Federal Reserve attempted to depreciate the dollar in order to narrow the trade gap. This view was also supported by the significant depreciation in the dollar in response to the announcements found over this interval. For trade announcements during the 1986.8 to 1988.7 period, interest rates increased with the announcement of large trade deficits, while the dollar continued to depreciate on announcement. The increase in short-term interest rates is consistent with the likely change in the Federal Reserves reaction function to trade deficit announcements over that period. On the other hand, the fact that interest rates across the entire maturity structure increased with the announcement, while the dollar depreciated, is more consistent with an increase in risk premia associated with holding dollar-denominated assets that may have occurred since 1987.

ACKNOWLEDGMENTS
The authors would like to thank an anonymous referee for helpful suggestions this paper. Any remaining errors are our own responsibility. on an earlier version of

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KEVIAN DERAVI, PHILIP GREGOROWICZ,

and CHARLES HEGJI

NOTES
1. The parameter estimate of the expected component of the announcement for 9O-day Treasury bills is also significant, at the 10% level. This reveals some market inefficiency and is consistent with findings of other announcement studies (Falk and Orazam, 1985, Roley, 1982, Urich and Wachtel, 1981). 2. The authors would like to thank the referee for suggesting this explanation of the results over the 1986-1988 sub-interval.

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Exchange and Interest Rates

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Pearce, D. H. and V.V. Roley. Stock Prices and Economic News, Journal ofBu.siness 58 (January 1985): 49-67. Roley, Vance. Weekly Money Supply Announcements and the Volatility of Short Term Interest Rates. Federal Reserve Bank of Kansas City, Economic Review (April 1982): 3-15. Urich, Thomas J. and Paul Wachtel. Market Responses to the Weekly Money Supply Announcements in the 1970s. Journal ofFinance (December 1981): 1063-1072. The Wall Street Journal, Dow Jones and Company, Various issues, 1980-1988.