Do We Need Multi-Country Models to Explain Exchange Rate, Interest Rate and Bond Return Dynamics?

39 Pages Posted: 6 Dec 2001

See all articles by Robert J. Hodrick

Robert J. Hodrick

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Maria Vassalou

Centre for Economic Policy Research (CEPR)

Date Written: November 2001

Abstract

This Paper examines characterizations of the dynamics for first and second moments of the one-month interest rate, the 12-month excess bond return and exchange rates. The countries considered are the US, Germany, Japan and the UK. Our tests are based on the implications of multi-country versions of the Cox, Ingersoll and Ross (1985) class of term structure models. Multi-country models are in several cases better able to explain the dynamics of one-month interest rates and the 12-month excess bond returns than one-country models. Furthermore, in some cases, they can also explain the dynamics of the exchange rates better than two-country models. Multi-country models are particularly useful for explaining the second moment of the one-month US interest rate, the second moments of the 12-month excess bond returns in US, Germany and Japan, as well as the first moment of the rate of appreciation of the Deutsche mark relative to the US dollar. In addition to results based on asymptotic distributions, we also provide inference using the small-sample distributions of test statistics.

Keywords: Exchange rates, interest rates, bond returns, multi-country models

JEL Classification: C61, E40

Suggested Citation

Hodrick, Robert J. and Vassalou, Maria, Do We Need Multi-Country Models to Explain Exchange Rate, Interest Rate and Bond Return Dynamics? (November 2001). CEPR Discussion Paper No. 3056. Available at SSRN: https://ssrn.com/abstract=293255

Robert J. Hodrick (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

365 Fifth Avenue, 5th Floor
New York, NY 10016-4309
United States

Maria Vassalou

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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