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Beyond Carry: The Prospective Interest Rate Differential and Currencuy Excess Returns

Author

Listed:
  • Dong, Mike

    (U of California, Riverside)

  • Goto, Shingo

    (U of Rhode Island)

  • Xu, Yan

    (Ohio State U)

  • Zhang, Yuzhao

    (HKU)

Abstract

We use a Beveridge-Nelson decomposition to link expected foreign-currency excess returns to the "prospective interest rate differential"--the infinite sum of expected future interest rate differentials. Empirically, we find our prospective interest rate differential is a stronger predictor of currency excess returns than carry, in both portfolio sorts and Fama-MacBeth regressions. A factor based on the prospective interest rate differential is also useful in explaining the returns of a broad set of currency test portfolios.

Suggested Citation

  • Dong, Mike & Goto, Shingo & Xu, Yan & Zhang, Yuzhao, 2024. "Beyond Carry: The Prospective Interest Rate Differential and Currencuy Excess Returns," Working Paper Series 2024-03, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2024-03
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    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • 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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