Working Paper: CEPR ID: DP3056
Authors: Robert J. Hodrick; Maria Vassalou
Abstract: This Paper examines characterizations of the dynamics for first and second moments of the one-month interest rate, the 12-month excess bond return and exchange rates. The countries considered are the US, Germany, Japan and the UK. Our tests are based on the implications of multi-country versions of the Cox, Ingersoll and Ross (1985) class of term structure models. Multi-country models are in several cases better able to explain the dynamics of one-month interest rates and the 12-month excess bond returns than one-country models. Furthermore, in some cases, they can also explain the dynamics of the exchange rates better than two-country models. Multi-country models are particularly useful for explaining the second moment of the one-month US interest rate, the second moments of the 12-month excess bond returns in US, Germany and Japan, as well as the first moment of the rate of appreciation of the Deutsche mark relative to the US dollar. In addition to results based on asymptotic distributions, we also provide inference using the small-sample distributions of test statistics.
Keywords: bond returns; exchange rates; interest rates; multicountry models
JEL Codes: C61; E40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| multicountry models (O57) | one-month interest rates (E43) |
| multicountry models (O57) | 12-month excess bond returns (G12) |
| multicountry models (O57) | second moment of one-month US interest rate (E43) |
| third-country interest rates (E43) | exchange rate movements (F31) |
| multicountry models (O57) | volatility of interest rates (E43) |
| multicountry models (O57) | dynamics of exchange rates (F31) |
| multicountry models (O57) | explanatory power compared to one-country models (C20) |