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

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Author Info
Shu Wu (Department of Economics, The University of Kansas)
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.

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Paper provided by University of Kansas, Department of Economics in its series WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS with number 200519.

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Length: 27 pages
Date of creation: Oct 2005
Date of revision: Oct 2005
Handle: RePEc:kan:wpaper:200519

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Related research
Keywords: forward premium puzzle; the term structure of interest rates;

Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Leo Krippner, 2006. "A Yield Curve Perspective on Uncovered Interest Parity," Working Papers in Economics 06/16, University of Waikato, Department of Economics. [Downloadable!]
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