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Bonds, currencies and expectational errors

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  • Granziera, Eleonora
  • Sihvonen, Markus

Abstract

We propose a model in which sticky expectations concerning short-term interest rates generate joint predictability patterns in bond and currency markets. Our parsimonious specification can explain the downward sloping term structure of carry trade returns, difficult to replicate in a rational expectations framework. We offer empirical support for our approach and show that including a sticky short rate expectations channel into a standard affine term structure allows the model to better capture the drift patterns in the data.

Suggested Citation

  • Granziera, Eleonora & Sihvonen, Markus, 2024. "Bonds, currencies and expectational errors," Journal of Economic Dynamics and Control, Elsevier, vol. 158(C).
    • Handle: RePEc:eee:dyncon:v:158:y:2024:i:c:s0165188923001963
    DOI: 10.1016/j.jedc.2023.104790
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    More about this item

    Keywords

    Bond and currency premia; Sticky expectations; Interest rate forecast errors;
    All these keywords.

    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
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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