The euro to dollar exchange rate in the Covid‐19 era: Evidence from spectral causality and Markov‐switching estimation

Abstract

In this paper, we analyse how the Covid‐19 pandemic changed the dynamics of the euro to dollar exchange rate. To do so, we make use of spectral non‐causality tests to uncover the determinants of the euro to dollar exchange rate, using data that cover the pre‐Covid‐19 and the actual Covid‐19 era, by considering the exchange rate movements of other currencies, the stock market index of S&P 500, and the price of oil and gold, as well as their realized volatilities. Based on our findings, the Covid‐19 pandemic has indeed significantly changed the determinants of the euro to dollar exchange rate. Also, to investigate the potential shifts in the regimes of the euro to dollar exchange rate, we formulate a Markov‐switching model with two regimes, based on the determinants that have been found in the previous step. Based on our findings, the duration of the high volatility state in the Covid‐19 era has doubled, from almost 3 to approximately 6 days, compared to the pre‐Covid‐19 era, whereas the high volatility state in the Covid‐19 era is characterized by a statistically significant higher range of volatility compared to the pre‐Covid‐19 era.