Multihorizon Currency Returns and Purchasing Power Parity

Mikhail Chernov and Drew Creal

No 24563, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Exposures of expected future depreciation rates to the current interest rate differential violate the UIP hypothesis in a distinctive pattern that is a non-monotonic function of horizon. Conversely, forward, or risk-adjusted expected depreciation rates are monotonic. We explain the two patterns jointly by incorporating the weak form of PPP, aka stationarity of the real exchange rate, into a joint model of the stochastic discount factor, the nominal exchange rate, inflation differential, domestic and foreign yield curves. Short-term departures from PPP generate the first pattern. The risk premiums for these departures generate the second pattern. Thus, the variance of the stochastic discount factor must be related to the real exchange rate deepening the exchange rate disconnect.

JEL-codes: F31 F47 G12 G15 (search for similar items in EconPapers)
Date: 2018-04
New Economics Papers: this item is included in nep-mon and nep-opm
Note: AP IFM
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Working Paper: Multihorizon Currency Returns and Purchasing Power Parity (2018)
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