Exchange Rate Determinants | Summary and Q&A

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September 28, 2020
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Stanford Graduate School of Business
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Exchange Rate Determinants

TL;DR

Currency markets and exchange rates are influenced by forces such as interest rate differentials, risk premia, and convenience yields.

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Questions & Answers

Q: How are currency markets and bond markets connected?

Currency markets and bond markets are tightly connected, as exchange rates need to continuously adjust to align returns with risks for both domestic and foreign bond market investors.

Q: What are the main forces that determine exchange rates?

The main forces include shocks to future interest rates, deviations from uncovered interest rate parity, and deviations from covered interest rate currency parity. These forces collectively determine the level of exchange rates.

Q: Why do high currency risk premia tend to be offset by low or negative bond risk premia?

High interest rate currencies are perceived as riskier by investors, leading to higher currency risk premia. However, these premia are offset by low or negative bond risk premia, making the currencies attractive to investors.

Q: How do long-term interest rates influence exchange rates?

Long-term interest rate differences between countries are a crucial determinant of exchange rates. An increase in long-term yields in one country relative to another will lead to an appreciation of the currency.

Summary & Key Takeaways

  • The presenter provides an overview of the research conducted in asset pricing and international finance, focusing on exchange rates and currency markets.

  • Exchange rates are affected by factors such as shocks to interest rates, deviations from uncovered interest rate parity, and deviations from covered interest rate currency parity.

  • Shocks to discount rates and deviations from uncovered interest rate parity play a significant role in determining exchange rate variations.

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