Purpose: The paper carries out an empirical investigation of information implied in the term structures of interest rate on exchange rate dynamics. Key literature / theoretical perspective: Empirical study on exchange rate economics which relate exchange rate to monetary variables, interest rates, prices has not been satisfactory (see, Meese, RA and Rogoff (1983), Lucio (2005)) Indeed, macroeconomics fundamentals are the main driving force of exchange rate movement, However, conventional measure of macroeconomics fundamental are not precise enough. The proxy variable of macroeconomics fundamentals may provide poor measure of expected future fundamentals. The shape of yield curve reflects expected future economic activity for variables such as inflation, economic growth, and real consumption growth. [see, for example, Fama (1990), , Mishkin (1990b), Rendu de Lint and Stolin (2003), Diebold, Rudebusch and Aruoba (2006)]. We incorporate the information on macroeconomic fundamentals behind the relative factors of yield curve to forecast exchange rate changes. Design/methodology/approach: We use end-of-month zero coupon yields at maturity from 3 month to 120 months for Australian Dollar and USD to estimate relative yield curve factors. Follow Chen and Tsang (2009), we employ three relative factors excluded from Equation (9) to test the predictability of these factor on the changes in exchange rate and currency returns for horizons m= 1, 3, 6, 12, 18 and 24 months. Findings: Our results show that the relative slope and curvature factors of cross country yield curve can predict exchange rate movement and excess returns from one month to two year ahead.
|Number of pages||2|
|Journal||Expo 2011 Higher Degree Research : book of abstracts|
|Publication status||Published - 2011|
|Event||Higher Degree Research Expo (7th : 2011) - Sydney|
Duration: 10 Oct 2011 → 11 Oct 2011
- exchange rate
- term structure of interest rate