Working Paper: NBER ID: w29875
Authors: Pierre-Olivier Gourinchas; Walker D. Ray; Dimitri Vayanos
Abstract: We develop a two-country model in which currency and bond markets are populated by different investor clienteles, and segmentation is partly overcome by arbitrageurs with limited capital. Risk premia in our model are time-varying, connected across markets, and consistent with the empirical violations of Uncovered Interest Parity and Expectations Hypothesis. Through risk premia, large-scale bond purchases lower domestic and foreign bond yields and depreciate the currency, and short-rate cuts lower foreign yields, with smaller effects than bond purchases. Currency returns are disconnected from long-maturity bond returns, and yet the currency market is instrumental in transmitting bond demand shocks across countries.
Keywords: No keywords provided
JEL Codes: F31; F41; F42; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large-scale purchases of long maturity bonds (G12) | lower domestic and foreign bond yields (E43) |
| large-scale purchases of long maturity bonds (G12) | currency depreciation (F31) |
| conventional monetary policy (E52) | domestic bond yields (H63) |
| conventional monetary policy (E52) | international bond yields (E43) |
| unconventional monetary policy (E59) | international bond yields (E43) |
| QE purchases by the home central bank (E58) | depreciation of the home currency (F31) |
| QE purchases by the home central bank (E58) | lower foreign bond yields (E43) |
| cut in the home short rate (E43) | engagement in currency carry trade (CCT) (F31) |
| engagement in currency carry trade (CCT) (F31) | appreciation of the exchange rate (F31) |