Exchange rates and interest rates: can term structure models explain currency movements? [An article from: Journal of Economic Dynamics and Control]

This digital document is a journal article from Journal of Economic Dynamics and Control, published by Elsevier in 2004. The article is delivered in HTML format and is available in your Amazon.com Media Library immediately after purchase. You can view it with any web browser.

Description:
We construct an international term structure model that has excellent empirical performance in tracking movements of exchange rates and currency returns. The forward premium puzzle is accounted for, yet the model does not have the undesirable properties found in Backus et al. (J. Finance 56 (2001) 279). Examination of the estimated factor structure indicates that local factors are not important in the US, UK, and German markets. Moreover, we find that term structure factors alone cannot satisfactorily explain exchange rate movements. In other words, exchange rates are also affected by other factors that are not in the interest rate dynamics.