Exchange Rate Determinants | Summary and Q&A

TL;DR

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

Key Insights

• 💱 Currency markets and bond markets are closely linked, with exchange rates adjusting to align returns with risks.
• ☠️ Shocks to discount rates and deviations from uncovered interest rate parity are significant determinants of exchange rate variations.
• ☠️ Long-term interest rate differences between countries play a crucial role in shaping exchange rates.
• ☠️ Convenience yields, which reflect safe asset demand, impact exchange rates.
• ☠️ Models based on long-run uncovered interest rate parity provide a better understanding of exchange rate dynamics.
• 💱 High currency risk premia are offset by low or negative bond risk premia in some currencies.
• ☠️ Quantitative easing and other policy measures can have implications for exchange rates.

Transcript

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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.