Bond Convenience Yields and Exchange Rate Dynamics

Rosen Valchev

American Economic Journal: Macroeconomics, 2020, vol. 12, issue 2, 124-66

Abstract: This paper proposes a new explanation for the failure of Uncovered Interest Parity (UIP) that rationalizes both the classic UIP puzzle and the evidence that the puzzle reverses direction at longer horizons. In the model, excess currency returns arise as compensation for endogenous fluctuations in bond convenience yield differentials. Due to the interaction of monetary and fiscal policy, the impulse response of the equilibrium convenience yield is nonmonotonic, which generates the reversal of the puzzle. The calibrated model fits exchange rate dynamics very well. I also find direct evidence linking convenience yields to excess currency returns.

JEL-codes: E43 E52 F31 F41 H63 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (48)

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Working Paper: Bond Convenience Yields and Exchange Rate Dynamics (2017)
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DOI: 10.1257/mac.20170391

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