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In this paper the authors empirically investigate whether interest rate changes by the European Central Bank and the U.S. Federal Reserve influence the bid-ask currency spread between the U.S. dollar and the euro for the period January 3, 2006 through November 30, 2007. Evidence is presented that indicates that changes in the Federal Funds target rate may cause an increase in the spread and, therefore transactions costs, through recent increased volatility in the underlying spot exchange rate. However, rate changes announced by the European Central Bank dampens volatility in the spread through the same mechanism.
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