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

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  • Shu Wu

    (Department of Economics, The University of Kansas)

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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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File URL: http://www.ku.edu/~bgju/2005Papers/200519.pdf
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Bibliographic Info

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

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References

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Citations

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Cited by:
  1. Wagner, Christian, 2009. "Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation," MPRA Paper 21125, University Library of Munich, Germany.
  2. 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.
  3. Leo Krippner, 2006. "A Yield Curve Perspective on Uncovered Interest Parity," Working Papers in Economics 06/16, University of Waikato, Department of Economics.
  4. Ahmet Can √Ěnci, 2007. "Currency and yield Co-integration between a developed and an emerging Country: The Case of Turkey," Bogazici Journal of Economics and Administrative Sciences, Bogazici University, Department of Economics, vol. 21(1+2), pages 1-20.

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