A Quantity-Driven Theory of Term Premia and Exchange Rates

Robin Greenwood, Samuel Hanson, Jeremy Stein and Adi Sunderam

No 27615, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a model in which specialized bond investors must absorb shocks to the supply and demand for long-term bonds in two currencies. Since long-term bonds and foreign exchange are both exposed to unexpected movements in short-term interest rates, a shift in the supply of long-term bonds in one currency influences the foreign exchange rate between the two currencies, as well as bond term premia in both currencies. Our model matches several important empirical patterns, including the co-movement between exchange rates and term premia, as well as the finding that central banks' quantitative easing policies impact exchange rates. An extension of our model sheds light on the persistent deviations from covered interest rate parity that have emerged since 2008.

JEL-codes: F31 G12 (search for similar items in EconPapers)
Date: 2020-07
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-mon
Note: AP IFM
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Citations: View citations in EconPapers (19)

Published as Robin Greenwood & Samuel Hanson & Jeremy C Stein & Adi Sunderam, 2023. "A Quantity-Driven Theory of Term Premia and Exchange Rates," The Quarterly Journal of Economics, vol 138(4), pages 2327-2389.

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