TITLE:
Exchange Rates, Macroeconomic Fundamentals and Risk Aversion
AUTHORS:
Ricardo Laborda, Jose Olmo
KEYWORDS:
Expectations Hypothesis, Foreign Exchange Markets, Monetary Model, Uncovered Interest Parity Condition
JOURNAL NAME:
Theoretical Economics Letters,
Vol.4 No.6,
June
13,
2014
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.