Do Term Premiums Matter? Transmission Via Exchange Rate Dynamics

44 Pages Posted: 10 Jun 2019

Date Written: May 20, 2019

Abstract

The macroeconomic effect of term premiums is a controversial issue both theoretically and quantitatively. In this paper, we explore the possibility that term premiums affect inflation and the real economy via exchange rate dynamics. For this purpose, we construct a small open economy model with limited asset market participation, focusing on the empirical fact that uncovered interest parity (UIP) holds better for longer-term interest rate differentials. A quantitative exercise using Japanese and U.S. data shows that changes in term premiums of both Japanese and U.S. long-term yields have sizable effects on Japanese inflation rates via exchange rate dynamics.

Keywords: Exchange Rate; Term Premium; Uncovered Interest Rate Parity

JEL Classification: E31; E52; E58

Suggested Citation

Katagiri, Mitsuru and Takahashi, Koji, Do Term Premiums Matter? Transmission Via Exchange Rate Dynamics (May 20, 2019). Available at SSRN: https://ssrn.com/abstract=3392729 or http://dx.doi.org/10.2139/ssrn.3392729

Mitsuru Katagiri

Bank of Japan ( email )

2-1-1 Nihonbashi-Hongokucho,Chuo-ku
Tokyo
Japan

HOME PAGE: http://www.boj.or.jp/en/about/index.htm/

Koji Takahashi (Contact Author)

Bank of Japan ( email )

CPO Box 203
Tokyo, 100-91
Japan

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