Exchange Rates, Macroeconomic Fundamentals and Risk Aversion

Ricardo Laborda, Jose Olmo

Centro Universitario de la Defensa, Zaragoza, Spain.
University of Southampton, Southampton, UK.

DOI: 10.4236/tel.[phone]                

Abstract

This paper proposes a theoretical model for determining the exchange rate based on the interaction between international bond markets with different maturities. The model accommodates the presence of risk premia between short- and long-term bonds. The difference in risk premium between international bond markets produces imbalances between their yields and is responsible for the differences in equilibrium between the future spot exchange rate and the corresponding forward price. These departures from the expectations hypothesis of the international term structure of interest rates lead to unintended effects on the efficacy of monetary policy in open economies. The existence of imbalances in the risk premium between countries can be considered by monetary authorities as an alternative tool for conducting monetary policy and boosting real output.

Keywords

Expectations Hypothesis, Foreign Exchange Markets, Monetary Model, Uncovered Interest Parity Condition

Conflicts of Interest

The authors declare no conflicts of interest.

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