The PPP View of Multihorizon Currency Risk Premiums. (29th September 2020)

• Record Type: Journal Article
• Authors: Chernov, Mikhail; Creal, Drew
• Editors: Koijen, Ralph
• Is Part Of: Review of financial studies. Volume 34:Number 6(2021)
• Page Start: 2728
• Page End: 2772
• Publication Date: 2020-09-29
• Subjects: F31 -- F47 -- G12 -- G15; Finance -- United States -- Periodicals; Finance -- Periodicals; 332
• DOI: 10.1093/rfs/hhaa114
• Languages: English
• ISSNs: 0893-9454

Abstract

Abstract: Exposures of expected future nominal depreciation rates to the current interest rate differential violate the UIP hypothesis in a pattern that is a nonmonotonic function of horizon. Forward expected nominal depreciation rates are monotonic. We explain the two patterns by simultaneously incorporating the weak form of PPP into a joint model of the stochastic discount factor, the nominal exchange rate, and domestic and foreign yield curves. Departures from PPP generate the first pattern. The risk premiums for these departures generate the second pattern. Thus, the variance of the stochastic discount factor is related to the real exchange rate.