NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Hot Tip: Nominal Exchange Rates and Inflation Indexed Bond Yields

Richard H. Clarida

NBER Working Paper No. 18726
Issued in January 2013
NBER Program(s):   IFM

This paper derives a structural relationship between the nominal exchange rate, national price levels, and observed yields on long maturity inflation - indexed bonds. This relationship can be interpreted as defining the fair value of the exchange rate that will prevail in any model or real world economy in which inflation indexed bonds are traded. An advantage of our derivation is that it does not require restrictive assumptions on financial market equilibrium to be operational. We take our theory to a dataset spanning the period January 2001 - February 2011 and study a daily , real time decompositions of pound, euro, and yen exchange rates into their fair value and risk premium components. The relative importance of these two factors varies depending on the sub sample studied. However, sub samples in which we find correlations of 0.30 to 0.60 between daily exchange rate changes and daily changes in fair value are not uncommon. We also show empirically and justify theoretically that a 1 percent rise in the foreign currency risk premium is on average contemporaneously associated with a 50 basis point rise in the inflation indexed bond return differential in favor of the foreign country and an 50 basis point appreciation of the dollar

download in pdf format
   (1864 K)

email paper

A non-technical summary of this paper is available in the June 2013 NBER digest.  You can sign up to receive the NBER Digest by email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w18726

Published: The Role of Currency in Institutional Portfolios Edited By Momtchil Pojarliev and Richard M. Levich Chapter 17: Exchange Rates, Risk Premia, and Inflation Indexed Bond Yields Richard Clarida (Columbia University, NBER, and PIMCO) and Shaowen Luo (Columbia University)

Users who downloaded this paper also downloaded these:
Boudoukh, Feldman, Kogan, and Richardson w18725 Which News Moves Stock Prices? A Textual Analysis
Gordon and Dahl w18728 Views among Economists: Professional Consensus or Point-Counterpoint?
Burstein and Gopinath w18829 International Prices and Exchange Rates
Collard-Wexler and De Loecker w18739 Reallocation and Technology: Evidence from the U.S. Steel Industry
Feldstein w16674 The Role of Currency Realignments in Eliminating the US and China Current Account Imbalances
 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us