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Interest Rate Risk and the Forward Premium Anomaly in Foreign Exchange Markets

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  • SHU WU

Abstract

This paper shows that even adjusted for the time-varying risk premiums implied by the yield curves across countries, uncovered interest parity is still strongly rejected by the data. Moreover, factors that predict the excess bond returns are found not significant at all in predicting the foreign exchange returns. These results reject the joint restrictions on the exchange rate and interest rates imposed by dynamic term-structure models, suggesting that foreign exchange markets and bond markets may not be fully integrated and we have to look beyond interest rate risk in order to understand the exchange rate anomaly. Copyright 2007 The Ohio State University.

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  • Shu Wu, 2007. "Interest Rate Risk and the Forward Premium Anomaly in Foreign Exchange Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 423-442, March.
    • Handle: RePEc:mcb:jmoncb:v:39:y:2007:i:2-3:p:423-442
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    Cited by:

    1. Vania Stavrakeva & Jenny Tang, 2015. "Exchange rates and monetary policy," Working Papers 15-16, Federal Reserve Bank of Boston.
    2. Wagner, Christian, 2012. "Risk-premia, carry-trade dynamics, and economic value of currency speculation," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1195-1219.
    3. Carmen Gloria Silva, 2010. "Forward premium puzzle and term structure of interest rates: the case of New Zealand," Working Papers Central Bank of Chile 570, Central Bank of Chile.
    4. Antonio Diez De Los Rios, 2009. "Can Affine Term Structure Models Help Us Predict Exchange Rates?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(4), pages 755-766, June.
    5. Stavrakeva, Vania & Tang, Jenny, 2016. "Exchange rates and the yield curve," Working Papers 16-21, Federal Reserve Bank of Boston.
    6. Yutaka Kurihara, 2016. "Effectiveness of the Zero Interest Rate Policy for Financial Markets in Japan: Principal Components Analysis," Applied Economics and Finance, Redfame publishing, vol. 3(3), pages 103-111, August.
    7. Yutaka Kurihara, 2015. "Are Japanese Stock Prices Important Deterministic Elements of Exchange Rate Returns?," Bulletin of Applied Economics, Risk Market Journals, vol. 2(2), pages 1-9.
    8. Ahmet Can Ýnci, 2007. "Currency and yield Co-integration between a developed and an emerging Country: The Case of Turkey," Bogazici Journal, Review of Social, Economic and Administrative Studies, Bogazici University, Department of Economics, vol. 21(1+2), pages 1-20.
    9. Leo Krippner, 2006. "A Yield Curve Perspective on Uncovered Interest Parity," Working Papers in Economics 06/16, University of Waikato.
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    JEL classification:

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

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