Liquidity yield and exchange rate predictability

Shiu-Sheng Chen and Yu-Hsi Chou

Journal of International Money and Finance, 2023, vol. 137, issue C

Abstract: In this paper, we extend the Taylor rule model of exchange rate determination by incorporating the liquidity yield on government bonds, and investigate exchange rate predictability from the augmented Taylor rule model. We find that the liquidity yield on government bonds delivers additional predictive power to future exchange rate movements beyond the model with Taylor rule fundamentals, using both in-sample and out-of-sample tests. In particular, the augmented model with liquidity yield exhibits superior predictive power after the currency swap market frictions are controlled.

Keywords: Liquidity Yield; Meese–Rogoff Puzzle; Exchange Rate Forecasting (search for similar items in EconPapers)
JEL-codes: F31 F41 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:137:y:2023:i:c:s0261560623001043

DOI: 10.1016/j.jimonfin.2023.102903

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