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The First Arrow Hitting the Currency Target: A Long-run Risk Perspective


  • KANO, Takashi
  • WADA, Kenji


This paper reconsiders the successful currency outcome of the first arrow of the Abenomics. The Japanese yen depreciation against the U.S. dollar after the introduction of the first arrow comoves tightly with long-term yield differentials between Japan and the United States. The estimated term structure of the sensitivity of the currency return of the Japanese yen to the two-country interest rate differential indeed shifts up and becomes steeper after the onset of the Abenomics. To explain this structural change in the term structure of the Fama regression coeffiient, we employ a long-run risk model endowed with real and nominal conditional volatilities as in Bansal and Shaliastovich (2013). Under a plausible calibration, the model replicates the structural change when nominal uncertainty dominates real uncertainty in the U.S. bond market. We conjecture that the arrow was shot off from the U.S. side, not the Japan side.

Suggested Citation

  • KANO, Takashi & WADA, Kenji, 2015. "The First Arrow Hitting the Currency Target: A Long-run Risk Perspective," Discussion paper series HIAS-E-13, Hitotsubashi Institute for Advanced Study, Hitotsubashi University.
  • Handle: RePEc:hit:hiasdp:hias-e-13
    Note: Current Draft: November 9, 2015

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    References listed on IDEAS

    1. Ravi Bansal & Ivan Shaliastovich, 2013. "A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets," Review of Financial Studies, Society for Financial Studies, vol. 26(1), pages 1-33.
    2. Ralph S. J. Koijen & Hanno Lustig & Stijn Van Nieuwerburgh & Adrien Verdelhan, 2010. "Long Run Risk, the Wealth-Consumption Ratio, and the Temporal Pricing of Risk," American Economic Review, American Economic Association, vol. 100(2), pages 552-556, May.
    3. Kano, Takashi & Morita, Hiroshi, 2015. "An equilibrium foundation of the Soros chart," Journal of the Japanese and International Economies, Elsevier, vol. 37(C), pages 21-42.
    4. Kazuo Ueda, 2013. "Response of Asset Prices to Monetary Policy under Abenomics," Asian Economic Policy Review, Japan Center for Economic Research, vol. 8(2), pages 252-269, December.
    5. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, August.
    6. Fujiwara, Ippei & Nakazono, Yoshiyuki & Ueda, Kozo, 2015. "Policy regime change against chronic deflation? Policy option under a long-term liquidity trap," Journal of the Japanese and International Economies, Elsevier, vol. 37(C), pages 59-81.
    7. Fukuda, Shin-ichi, 2015. "Abenomics: Why was it so successful in changing market expectations?," Journal of the Japanese and International Economies, Elsevier, vol. 37(C), pages 1-20.
    8. Abrahams, Michael & Adrian, Tobias & Crump, Richard K. & Moench, Emanuel & Yu, Rui, 2016. "Decomposing real and nominal yield curves," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 182-200.
    9. Riccardo Colacito & Mariano M. Croce, 2013. "International Asset Pricing with Recursive Preferences," Journal of Finance, American Finance Association, vol. 68(6), pages 2651-2686, December.
    10. Adrian, Tobias & Crump, Richard K. & Moench, Emanuel, 2013. "Pricing the term structure with linear regressions," Journal of Financial Economics, Elsevier, vol. 110(1), pages 110-138.
    11. Riccardo Colacito & Mariano M. Croce, 2011. "Risks for the Long Run and the Real Exchange Rate," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 153-181.
    12. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, February.
    13. Kazuo Ueda, 2013. "The Response of Asset Prices to Monetary Policy under Abenomics," CIRJE F-Series CIRJE-F-894, CIRJE, Faculty of Economics, University of Tokyo.
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    Cited by:

    1. Hiroshi Ugai, 2015. "Transmission Channels and Welfare Implications of Unconventional Monetary Easing Policy in Japan," UTokyo Price Project Working Paper Series 060, University of Tokyo, Graduate School of Economics, revised Dec 2015.
    2. repec:tcr:wpaper:e102 is not listed on IDEAS
    3. Mitsuru Katagiri & Koji Takahashi, 2017. "Do Term Premiums Matter? Transmission via Exchange Rate Dynamics," Bank of Japan Working Paper Series 17-E-7, Bank of Japan.

    More about this item


    Japanese yen/U.S. dollar exchange rate; Term structure; Fama regression; Long-run risk; Abenomics;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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