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Bond Convenience Yields and Exchange Rate Dynamics

Rosen Valchev

No 943, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: This paper proposes a new explanation for the failure of Uncovered Interest Parity (UIP) that rationalize 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 equilib- rium convenience yield is non-monotonic, which generates the reversal of the puzzle. The model fits exchange rate dynamics very well, and I also find direct evidence that convenience yields indeed drive excess currency returns.

Keywords: Uncovered Interest Rate Parity; Exchange Rates; Open Economy Macroeconomics; Bond Convenience Yield; Monetary-Fiscal Interaction; Government Debt Dynamics (search for similar items in EconPapers)
JEL-codes: F31 F41 F42 E43 E52 E63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac, nep-mon and nep-opm
Date: 2017-10-16
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