Multihorizon Currency Returns and Purchasing Power Parity

59 Pages Posted: 2 May 2018

See all articles by Mikhail Chernov

Mikhail Chernov

UCLA Anderson

Drew Creal

University of Chicago - Booth School of Business - Econometrics and Statistics

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Date Written: April 2018

Abstract

Exposures of expected future depreciation rates to the current interest rate differential violate the UIP hypothesis in a distinctive pattern that is a non-monotonic function of horizon. Conversely, forward, or risk-adjusted expected depreciation rates are monotonic. We explain the two patterns jointly by incorporating the weak form of PPP, aka stationarity of the real exchange rate, into a joint model of the stochastic discount factor, the nominal exchange rate, inflation differential, domestic and foreign yield curves. Short-term 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 must be related to the real exchange rate deepening the exchange rate disconnect.

Suggested Citation

Chernov, Mikhail and Creal, Drew, Multihorizon Currency Returns and Purchasing Power Parity (April 2018). NBER Working Paper No. w24563, Available at SSRN: https://ssrn.com/abstract=3170816

Mikhail Chernov (Contact Author)

UCLA Anderson ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Drew Creal

University of Chicago - Booth School of Business - Econometrics and Statistics ( email )

Chicago, IL 60637
United States

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