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Convenience yield and real exchange rate dynamics: A present‐value interpretation

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  • Yu‐Hsi Chou
  • Chia‐Yi Yen

Abstract

In this paper, we empirically investigate the relationship between the convenience yield of government bonds and the real exchange rates using monthly data from 1999 to 2018. We extend the conventional models, based on the present‐value relationship between the real exchange rate and economic fundamentals, while explicitly considering the role of the convenience yield. Empirical results suggest that our present‐value models can capture the dynamic properties of the real exchange rate documented in the literature, including high persistence, excess volatility and excess co‐movement compared with real interest rate differentials. We also find that the sum of expected convenience yields significantly drives real exchange rate movements. Moreover, we find that foreign exchange swap market friction also plays a role in explaining real exchange rates. Finally, we find that monetary policy at the zero lower bound may be essential in real exchange rate modelling. Dynamique entre le rendement de détention et les taux de change réels : une interprétation de la valeur actualisée. Dans l'article, nous étudions de façon empirique la relation entre le rendement de détention des obligations d'État et les taux de change réels à l'aide des données mensuelles de 1999 à 2018. Nous élargissons les modèles conventionnels, en fonction de la relation en valeur actualisée entre les taux de change réels et les facteurs économiques fondamentaux, tout en tenant explicitement compte du rôle du rendement de détention. Les résultats empiriques donnent à penser que nos modèles de la valeur actualisée peuvent saisir les propriétés dynamiques des taux de change réels consignés dans la littérature, notamment la persistance élevée, la volatilité excessive et la covariation excessive comparativement aux différences du taux d'intérêt réel. Nous constatons également que la somme des rendements de détention attendus stimule nettement les mouvements des taux de change réels. En outre, nous observons que les frictions sur le marché de swap de devises jouent également un rôle dans l'explication des taux de change réels. Enfin, nous constatons que la politique monétaire à la borne du zéro peut être essentielle dans la modélisation des taux de change réels.

Suggested Citation

  • Yu‐Hsi Chou & Chia‐Yi Yen, 2023. "Convenience yield and real exchange rate dynamics: A present‐value interpretation," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 56(2), pages 453-489, May.
  • Handle: RePEc:wly:canjec:v:56:y:2023:i:2:p:453-489
    DOI: 10.1111/caje.12657
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    References listed on IDEAS

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