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On the driving forces of real exchange rates: Is the Japanese Yen different?

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  • Maio, Paulo
  • Zeng, Ming

Abstract

We estimate variance decompositions of the real exchange rate (q) for 19 currencies based on a present-value relation. At very short horizons, the driving force of q is predictability of the future exchange rate. At long horizons, return predictability drives most variation in q, with predictability of interest differentials playing a secondary role. This pattern is especially strong for the Non-G10 currencies. However, the long-run predictability mix associated with the Japanese Yen clearly deviates from the other currencies and is unstable over time. The quantitative simulation of a liquidity-based exchange rate model largely replicates our main empirical findings.

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  • Maio, Paulo & Zeng, Ming, 2023. "On the driving forces of real exchange rates: Is the Japanese Yen different?," Journal of Empirical Finance, Elsevier, vol. 74(C).
    • Handle: RePEc:eee:empfin:v:74:y:2023:i:c:s0927539823000907
    DOI: 10.1016/j.jempfin.2023.101423
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    More about this item

    Keywords

    Currency return and interest spread predictability; Japanese Yen; Variance decompositions; Present-value relation; Liquidity premium; Calibration and simulation;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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