On the driving forces of real exchange rates: Is the Japanese Yen different?

Paulo Maio and Ming Zeng

Journal of Empirical Finance, 2023, vol. 74, issue C

Abstract: We estimate variance decompositions of the real exchange rate (q) for 19 currencies based on a present-value relation. At very short horizons, the driving force of q is predictability of the future exchange rate. At long horizons, return predictability drives most variation in q, with predictability of interest differentials playing a secondary role. This pattern is especially strong for the Non-G10 currencies. However, the long-run predictability mix associated with the Japanese Yen clearly deviates from the other currencies and is unstable over time. The quantitative simulation of a liquidity-based exchange rate model largely replicates our main empirical findings.

Keywords: Currency return and interest spread predictability; Japanese Yen; Variance decompositions; Present-value relation; Liquidity premium; Calibration and simulation (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:74:y:2023:i:c:s0927539823000907

DOI: 10.1016/j.jempfin.2023.101423

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