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Currency forecast errors and carry trades at times of low interest rates: Evidence from survey data on the yen/dollar exchange rate

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  • MacDonald, Ronald
  • Nagayasu, Jun

Abstract

Using survey expectations data and a variant of the uncovered interest rate parity (UIRP), this paper evaluates the relationship between interest rates and investors' forecast errors about the yen/dollar exchange rate. This study therefore is related to the forward premium puzzle and the currency carry trade strategy. Using relatively short (i.e., 1 to 6 month-ahead) forecast data, we obtain the following results. First, with the same forecast horizon, exchange rate forecasts are homogeneous among different industry types, but within the same industry, exchange rate forecasts differ if the forecast time horizon is different. Second, while forecast errors are found to be partly driven by interest rate spreads, evidence against the UIRP is provided. Consistent with this finding, our coefficients on interest rate spreads obtained from nonlinear models provide indirect evidence of the yen carry trade. In particular, unlike theoretical predictions, the carry trade is found to be active during financial turmoil and when there is a clear indication that the interest rate will be low in the future.

Suggested Citation

  • MacDonald, Ronald & Nagayasu, Jun, 2015. "Currency forecast errors and carry trades at times of low interest rates: Evidence from survey data on the yen/dollar exchange rate," Journal of International Money and Finance, Elsevier, vol. 53(C), pages 1-19.
  • Handle: RePEc:eee:jimfin:v:53:y:2015:i:c:p:1-19
    DOI: 10.1016/j.jimonfin.2014.12.011
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    3. Kunze, Frederik, 2017. "Predicting exchange rates in Asia: New insights on the accuracy of survey forecasts," University of Göttingen Working Papers in Economics 326, University of Goettingen, Department of Economics.
    4. Li, XiaoPing & Tong, Bin & Zhou, ChunYang, 2020. "Uncertainty aversion, carry trades and agent heterogeneity in the FX market," Finance Research Letters, Elsevier, vol. 36(C).
    5. Lei Pan & Svetlana Maslyuk-Escobedo & Vinod Mishra, 2019. "Carry Trade Returns and Commodity Prices under Capital and Interest Rate Controls: Empirical Evidence from China," Monash Economics Working Papers 16-18, Monash University, Department of Economics.
    6. Thomas Chuffart & Cyril Dell'Eva, 2020. "The role of carry trades on the effectiveness of Japan's quantitative easing," International Economics, CEPII research center, issue 161, pages 30-40.
    7. de Souza Vasconcelos, Camila & Hadad Júnior, Eli, 2023. "Forecasting exchange rate: A bibliometric and content analysis," International Review of Economics & Finance, Elsevier, vol. 83(C), pages 607-628.
    8. Michael D. Goldberg & Olesia Kozlova & Deniz Ozabaci, 2020. "Forward Rate Bias in Developed and Developing Countries: More Risky Not Less Rational," Econometrics, MDPI, vol. 8(4), pages 1-26, December.
    9. Zhang, Ziyun & Chen, Su & Li, Bo, 2022. "Does previous carry trade position affect following investors' decision-making and carry returns?," International Review of Financial Analysis, Elsevier, vol. 80(C).
    10. Lee A. Smales, 2022. "The influence of policy uncertainty on exchange rate forecasting," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 41(5), pages 997-1016, August.

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    More about this item

    Keywords

    Currency forecast errors; Uncovered interest parity; Forward premium puzzle; Carry trade; Markov-switching model; STAR model;
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    JEL classification:

    • F3 - International Economics - - International Finance

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