Hot Tip: Nominal Exchange Rates and Inflation Indexed Bond Yields

Richard Clarida

No 18726, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper derives a structural relationship between the nominal exchange rate, national price levels, and observed yields on long maturity inflation - indexed bonds. This relationship can be interpreted as defining the fair value of the exchange rate that will prevail in any model or real world economy in which inflation indexed bonds are traded. An advantage of our derivation is that it does not require restrictive assumptions on financial market equilibrium to be operational. We take our theory to a dataset spanning the period January 2001 - February 2011 and study a daily , real time decompositions of pound, euro, and yen exchange rates into their fair value and risk premium components. The relative importance of these two factors varies depending on the sub sample studied. However, sub samples in which we find correlations of 0.30 to 0.60 between daily exchange rate changes and daily changes in fair value are not uncommon. We also show empirically and justify theoretically that a 1 percent rise in the foreign currency risk premium is on average contemporaneously associated with a 50 basis point rise in the inflation indexed bond return differential in favor of the foreign country and an 50 basis point appreciation of the dollar

JEL-codes: F3 F31 (search for similar items in EconPapers)
Date: 2013-01
New Economics Papers: this item is included in nep-mon and nep-opm
Note: IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published as The Role of Currency in Institutional Portfolios Edited By Momtchil Pojarliev and Richard M. Levich Chapter 17: Exchange Rates, Risk Premia, and Inflation Indexed Bond Yields Richard Clarida (Columbia University, NBER, and PIMCO) and Shaowen Luo (Columbia University)

Downloads: (external link)
http://www.nber.org/papers/w18726.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:18726

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w18726

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().