Multihorizon Currency Returns and Purchasing Power Parity
63 Pages Posted: 1 May 2018 Last revised: 22 Oct 2018
Date Written: April 2018
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, risk-adjusted expected depreciation rates are monotonic. We explain the two patterns by incorporating the weak form of PPP into a no-arbitrage joint model of the depreciation 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.
Keywords: affine term structure model, cointegration, multiple horizons, purchasing power parity, uncovered interest parity
JEL Classification: F31, F47, G12, G15
Suggested Citation: Suggested Citation