Working Paper: NBER ID: w11077
Authors: Menzie D. Chinn; Guy Meredith
Abstract: The hypothesis that interest rate differentials are unbiased predictors of future exchange rate movements has been almost universally rejected in empirical studies. In contrast to previous studies, which have used short-horizon data, we test this hypothesis using interest rates on longer-maturity bonds for the U.S., Germany, Japan and Canada. The results of these long-horizon regressions are much more positive -- the coefficients on interest differentials are of the correct sign, and most are closer to the predicted value of unity than to zero. These results are robust to the use of different data frequencies, sample periods, yield definitions, and base currencies. We appeal to an econometric interpretation of the results, which focuses on the presence of simultaneity in a cointegration framework.
Keywords: No keywords provided
JEL Codes: F21; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Interest rate differentials (E43) | Future exchange rate movements (F31) |
| Long-horizon interest rate differentials (E43) | Future exchange rate movements (F31) |
| Short-horizon interest rate differentials (E43) | Future exchange rate movements (F31) |
| Forward rate (Y20) | Future exchange rate movements (F31) |
| Spot rate (E43) | Future exchange rate movements (F31) |