Central Bank Tone and Currency Risk Premia

I analyze how the tone of central bank press conferences impacts risk premia in the currency market. I measure tone as the difference between the number of hawkish and dovish phrases made during a press conference. I show that central bank tone contemporaneously explains option implied risk aversion, and predicts future variance swap returns. A one standard deviation increase in the hawkishness of a press conference increases option implied risk aversion by 1.5%, and reduces the one month variance swap return by 4.5% per year, relative to the average of -28.8% per year. In addition, I show that the impact of tone on currency markets comes primarily from the questions and answers, or the unscripted portion of the press conference.