Bond risk premia,macroeconomic fundamentals and the exchange rate |
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| Authors: | Marcello Pericoli Marco Taboga |
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| Institution: | 1. Department of Statistics, University of Sri Jayewardenepura, Sri Lanka;2. Monash Business School, Monash University, Melbourne, Australia;3. Centre for Financial Econometrics & Department of Finance, Deakin Business School, Deakin University, Melbourne, Australia;1. Economics and Planning Unit, Indian Statistical Institute, New Delhi 110016, India;2. Department of Economics, Shiv Nadar University, Uttar Pradesh 203207, India;1. School of Economics and Finance, Victoria University of Wellington, Rutherford House 23, Lambton Quay, Pipitea Campus, Wellington 6140, New Zealand;2. Department of Economics and Finance, City University of Hong Kong, 88 Tat Chee Avenue, Kowloon, Hong Kong;3. Department of Finance and Managerial Economics, School of Management, State University of New York at Buffalo, 335A Jacobs Management Center, Buffalo, New York 14260, United States;1. Eastern Mediterranean University, North Cyprus, Turkey;2. Federal College of Education (Technical), Potiskum, Yobe State, Nigeria;3. Montpellier Business School, University of Montpellier, Montpellier Research in Management, Montpellier, France;4. University of Nebraska-Omaha, USA |
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| Abstract: | We propose a two-country no-arbitrage term-structure model to analyze the joint dynamics of bond yields, macroeconomic variables and the exchange rate. The model allows to understand how exogenous shocks to the exchange rate affect the yield curves, how bond yields co-move in different countries and how the exchange rate is influenced by interest rates, macro-economic variables and time-varying bond risk premia.Estimating the model with US and German data, we find that time-varying bond risk premia account for a significant portion of the variability of the exchange rate: apparently, a currency tends to appreciate when investors expect large capital gains on long-term bonds denominated in that currency. A number of other novel empirical findings emerge. |
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