The Forward Premium Puzzle in a Two-Country World

Ian Martin

No 17564, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: I explore the behavior of asset prices and the exchange rate in a two-country world. When the large country has bad news, the relative price of the small country's output declines. As a result, the small country's bonds are risky, and uncovered interest parity fails, with positive excess returns available to investors who borrow at the large country's interest rate and lend at the small country's interest rate. I use a diagrammatic approach to derive these and other results in a calibration-free way.

JEL-codes: G12 G15 (search for similar items in EconPapers)
Date: 2011-11
New Economics Papers: this item is included in nep-opm
Note: AP EFG IFM
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Citations: View citations in EconPapers (29)

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