Dynamic Interactions between Government Bonds and Exchange Rate Expectations in Currency Options

HKIMR Working Paper No.18/2016

22 Pages Posted: 29 Sep 2016

See all articles by Cho-Hoi Hui

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department

Edward Tan

Hong Kong Monetary Authority

Date Written: September 28, 2016

Abstract

This paper examines the dynamic interactions between the government bond yields of Germany, Japan and the US and their exchange rate expectations anticipated in the currency options, i.e., risk reversals (put premia) of the US dollar versus the yen and euro. Short-term, one-way information flow from the government bond market to the currency option market was substantial before the introduction of quantitative easing by the US Fed in response to the 2008 global financial crisis; this pattern diminished after the 2013 taper tantrum. The long-term bond yields are important and separable determinants of the risk reversals. The negative relationship between the spreads of the US Treasury yield over the other two countries’ bond yields, and the dollar risk reversals indicating a fall in US dollar interest rate, implies dollar depreciation expectations embedded in currency option prices, not an appreciation, as predicted by uncovered interest rate parity.

Keywords: government bonds; currency options; quantitative easing; information flow

JEL Classification: F31; G13

Suggested Citation

Hui, Cho-Hoi and Tan, Edward, Dynamic Interactions between Government Bonds and Exchange Rate Expectations in Currency Options (September 28, 2016). HKIMR Working Paper No.18/2016. Available at SSRN: https://ssrn.com/abstract=2844663 or http://dx.doi.org/10.2139/ssrn.2844663

Cho-Hoi Hui (Contact Author)

Hong Kong Monetary Authority - Research Department ( email )

Hong Kong
China

Edward Tan

Hong Kong Monetary Authority ( email )

55/F, Two International Finance Centre
8 Finance Street, Central
Hong Kong
Hong Kong

Register to save articles to
your library

Register

Paper statistics

Downloads
37
Abstract Views
530
PlumX Metrics