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Uncovered Return Parity: Equity Returns and Currency Returns

Author

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  • Edouard Djeutem
  • Geoffrey R. Dunbar

Abstract

We propose an uncovered expected returns parity (URP) condition for the bilateral spot exchange rate. URP implies that unilateral exchange rate equations are misspecified and that equity returns also affect exchange rates. Fama regressions provide evidence that URP is statistically preferred to uncovered interest rate parity (UIP) for nominal bilateral exchange rates between the US dollar and six countries (Australia, Canada, Japan, Norway, Switzerland and the UK) at the monthly frequency. An implication of URP is that commodity price changes that affect equity returns thus affect bilateral exchange rates through the equity channel. We find evidence that the Australian, Canadian, Norwegian (post 2001) and UK (post 1992) expected exchange rates increase via the oil-equity channel as oil prices rise, whereas the Japanese and Swiss expected exchange rates decrease.

Suggested Citation

  • Edouard Djeutem & Geoffrey R. Dunbar, 2018. "Uncovered Return Parity: Equity Returns and Currency Returns," Staff Working Papers 18-22, Bank of Canada.
  • Handle: RePEc:bca:bocawp:18-22
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    References listed on IDEAS

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    1. Maurizio Michael Habib & Sascha Bützer & Livio Stracca, 2016. "Global Exchange Rate Configurations: Do Oil Shocks Matter?," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 64(3), pages 443-470, August.
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    6. Anna Pavlova & Roberto Rigobon, 2007. "Asset Prices and Exchange Rates," Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1139-1180.
    7. Hanno Lustig & Adrien Verdelhan, 2007. "The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk," American Economic Review, American Economic Association, vol. 97(1), pages 89-117, March.
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    More about this item

    Keywords

    Asset pricing; Exchange rates; International financial markets;

    JEL classification:

    • E - Macroeconomics and Monetary Economics
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F - International Economics
    • F3 - International Economics - - International Finance
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G - Financial Economics
    • G1 - Financial Economics - - General Financial Markets
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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