Forward and Spot Exchange Rates in a Multi-Currency World*

By Tarek A. Hassan, Rui Mano. Quarterly Journal of Economics, 2018

119 citations recorded by the source corpus.

We decompose violations of uncovered interest parity into a cross-currency, a betweentime-and-currency, and a cross-time component. We show that most of the systematic violations are in the cross-currency dimension. By contrast, we find no statistically reliable evidence that currency risk premia respond to deviations of forward premia from their time- and currency-specific mean. These results imply that the forward premium puzzle (FPP) and the carry-trade anomaly are separate phenomena that may require separate explanations. The carry trade is driven by static differences in interest rates across currencies, whereas the FPP appears to be driven primarily by cross-time variation in all currency risk premia against the US dollar. Models that feature two symmetric countries thus cannot explain either of the two phenomena. Once we make the appropriate econometric adjustments we also cannot reject the hypothesis that the elasticity of risk premia with respect to forward premia in all three dimensions is smaller than one. As a result, currency risk premia need not be correlated with expected changes in exchange rates.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/52bd98dab3c51975ade01eb930feef549d84ea7b

Citations in the corpus

• Trade Network Centrality and Currency Risk Premia (2019, unknown): “Lettau et al. (2014) show that the cross-section of currency returns can be priced by a model of downside risk.”
• Exchange Rate Disconnect in General Equilibrium (2017, unknown): “Additionally, for the moments that involve interest rates, we rely on the estimates in Hassan and Mano (2014) and Valchev (2020).”