Common Risk Factors in Currency Markets Lustig, Hanno; Roussanov, Nikolai; Verdelhan, Adrien
The Review of financial studies,
11/2011, Letnik:
24, Številka:
11
Journal Article
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We identify a "slope" factor in exchange rates. High interest rate currencies load more on this slope factor than low interest rate currencies. This factor accounts for most of the cross-sectional ...variation in average excess returns between high and low interest rate currencies. A standard, no-arbitrage model of interest rates with two factors—a country-specific factor and a global factor—can replicate these findings, provided there is sufficient heterogeneity in exposure to global or common innovations. We show that our slope factor identifies these common shocks, and we provide empirical evidence that it is related to changes in global equity market volatility. By investing in high interest rate currencies and borrowing in low interest rate currencies, U.S. investors load up on global risk.
US interest rate policy is shown to have a significant influence on emerging market bond spreads, but it is important to allow for non-linearities: US interest rates affect secondary market spreads ...differently, depending on countries' debt levels. Moderate debtors suffer little impact from an increase in US interest rates, while a country close to the borderline of solvency would face a much steeper increase in its spread. A 200 basis points increase in US short-term interest rates would increase emerging market spreads by 6–65
bps, depending on debt/GNI ratios.
We analyzed rationality, content, and anchoring of the monetary policy interest rate expectations (for 3, 6, 9, and 12 months ahead), taking into account the Brazilian data from January 2003 to July ...2020. We consider expectations based on two perspectives: expectations gathered from a Taylor rule and market expectations obtained from the survey carried out by the central bank. The findings point out that, concerning rationality and anchoring, the interest rate expectations based on a Taylor rule performed better than expectations from the Central Bank of Brazil's (CBB) survey, even when we consider the Top 5 forecasters. Moreover, our analysis shows that the content of monetary policy interest rate expectations based on a Taylor rule and CBB's survey (including Top 5 forecasters) is different. Thus, they may be seen as complementary sources of information on the future interest rate. Concerning anchoring of the monetary policy interest rate expectations, the CBB's survey expectations are not anchored, while the result for the expectations based on a Taylor rule shows the opposite for horizons up to 9 months ahead.
•In a “floor system”, interest rate and balance sheet policies are two independent instruments.•The “floor system” enhances the ability of central banks to keep the money market rates in line with ...their target level.•Monetary policy implementation should not go back to the “corridor” system.•In the “new normal” monetary policy should be implemented by steering interest rates within a floor system.
This article provides a simple model of monetary policy implementation, analyzing both the interest rate steering (IRS) and the quantitative easing (QE) policies. The model shows that the “floor system”, introduced with QE policies, is preferable to the traditional “corridor system”, for two reasons. First, it endows central banks with one more degree of freedom, since the interest rate and the balance sheet policies become two independent instruments. Second, it enhances the ability of central banks to keep the money market rates in line with their target level. This second prediction is confirmed by an empirical analysis of the money market in the euro area. Therefore, in the “new normal” monetary policy should be implemented by steering the level of interest rates within a floor system, instead of relying on the corridor system used in the old IRS framework.11I wish to thank the Reviewer and the Editor for their very useful comments on a previous version of this article.
This paper considers whether the use of real oil price data can improve upon the forecasts for the nominal interest rate in South Africa. We employ Bayesian vector autoregressive models that make use ...of various measures of oil prices and compare the forecasting results of these models with those that do not make use of this data. The real oil price data is also disaggregated into positive and negative components to establish whether this would improve upon the forecasting performance of the model. The full dataset includes quarterly measures of output, consumer prices, exchange rates, interest rates and oil prices, where the initial in-sample period extends from 1979q1 to 1997q4. We then perform recursive estimations and one- to eight-step ahead forecasts over the out-of-sample period 1998q1 to 2014q4. The results suggest that the models that include information relating to oil prices outperform the model that does not include this information, when comparing their out-of-sample properties. In addition, the model with the positive component of oil price tends to perform better than other models over the short to medium horizons. Then lastly, the model that includes both the positive and negative components of the oil price, provides superior forecasts over longer horizons, where the improvement is large enough to ensure that it is the best forecasting model on average. Hence, not only do real oil prices matter when forecasting interest rates, but the use of disaggregate oil price data may facilitate additional improvements.
•This paper considers whether the use of real oil price data can improve upon the forecasts of the interest rate in South Africa when using Bayesian vector autoregressive models.•The full dataset includes quarterly measures of output, consumer prices, exchange rates, interest rates and oil prices (or its disaggregated positive and negative components), where the initial in-sample extends from 1979q1 to 1997q4.•The evaluation makes use of rolling estimations and one- to eight-step ahead forecasts over the out-of-sample period 1998q1 to 2014q4.•The results suggest that the model with the positive component of oil price tends to perform better than other models over the short to medium horizons.•The model that includes both the positive and negative components of the oil price, provides superior forecasts at longer horizons, where the improvement is large enough to ensure that it is the best forecasting model on average.
This paper provides real-time evidence on the frequency, size, duration and economic significance of arbitrage opportunities in the foreign exchange market. We investigate deviations from the covered ...interest rate parity (CIP) condition using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency. The analysis unveils that: i) short-lived violations of CIP arise; ii) the size of CIP violations can be economically significant; iii) their duration is, on average, high enough to allow agents to exploit them, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency.
This article studies the sensitivity of the US stock market to nominal and real interest rates and inflation during the 2003-2013 period using quantile regression (QR). The empirical results show ...that the stock market has a significant sensitivity to changes in interest rates and inflation and finds differences across sectors and over time. Moreover, the effect of changes in both interest rates and inflation tends to be more pronounced during extreme market conditions, thus distinguishing expansion periods from recession periods.
This study investigates the long-run relationship between the exchange rate, interest rate, stock prices and output. The results demonstrate that a single restricted relationship is accepted when a ...structural break is incorporated into the cointegrating vector. Compared with the hypothesis tests on the single restricted relationship, the hypothetical structure comprising multiple relationships in the cointegrating vector is generally accepted in most countries, confirming the interaction between the relationships in the system. Our findings regarding the real exchange rate and stock price differentials appear to contradict the uncovered equity returns parity condition, whereas the relationship between the real exchange rate and interest rate differentials is consistent with the flexible price approach.
This study analyzes the interest rate pass-through (IRPT) from money market rates to various loan rates for up to 12 countries of the European Monetary Union (EMU) between 2003 and 2011 based on ...fully harmonized data. We first test for a cointegrating relationship between loan rates and the Euro OverNight Index Average (EONIA) and allow for different nonlinear patterns in the short-run adjustment of loan rates based on smooth transition models. Our results identify considerable differences in the size of the pass-through (PT) with respect to different loan rates or countries. In the majority of cases, the pass-through is incomplete, and the dynamics of loan adjustment are different for reductions and hikes in money market rates. A key finding is that the pass-through is more homogenous and more nearly complete for loans to non-financial corporations than to households.
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