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The PPP View of Multihorizon Currency Risk Premiums

Author

Listed:
  • Mikhail Chernov
  • Drew Creal

Abstract

Exposures of expected future nominal depreciation rates to the current interest rate differential violate the UIP hypothesis in a pattern that is a nonmonotonic function of horizon. Forward expected nominal depreciation rates are monotonic. We explain the two patterns by simultaneously incorporating the weak form of PPP into a joint model of the stochastic discount factor, the nominal exchange rate, and domestic and foreign yield curves. Departures from PPP generate the first pattern. The risk premiums for these departures generate the second pattern. Thus, the variance of the stochastic discount factor is related to the real exchange rate.

Suggested Citation

  • Mikhail Chernov & Drew Creal, 2021. "The PPP View of Multihorizon Currency Risk Premiums," The Review of Financial Studies, Society for Financial Studies, vol. 34(6), pages 2728-2772.
    • Handle: RePEc:oup:rfinst:v:34:y:2021:i:6:p:2728-2772.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhaa114
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    Citations

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    Cited by:

    1. Bacchetta, Philippe & van Wincoop, Eric, 2021. "Puzzling exchange rate dynamics and delayed portfolio adjustment," Journal of International Economics, Elsevier, vol. 131(C).
    2. Dahlquist, Magnus & Pénasse, Julien, 2022. "The missing risk premium in exchange rates," Journal of Financial Economics, Elsevier, vol. 143(2), pages 697-715.
    3. Mikhail Chernov & Magnus Dahlquist & Lars Lochstoer, 2023. "Pricing Currency Risks," Journal of Finance, American Finance Association, vol. 78(2), pages 693-730, April.
    4. Hansen, Anne Lundgaard, 2021. "Modeling persistent interest rates with double-autoregressive processes," Journal of Banking & Finance, Elsevier, vol. 133(C).

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • 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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