TY  - JOUR
AU  - Clarida,Richard H.
TI  - Hot Tip: Nominal Exchange Rates and Inflation Indexed Bond Yields
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 18726
PY  - 2013
Y2  - January 2013
UR  - http://www.nber.org/papers/w18726
L1  - http://www.nber.org/papers/w18726.pdf
N1  - Author contact info:
Richard H. Clarida
Columbia University
420 West 118th Street
Room 1111, IAB
New York, NY  10027
Tel: 212/854-3676
Fax: 212/854-8059
E-Mail: rhc2@columbia.edu
AB  - 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
ER  -