Forward-Looking Policy Rules and Currency Premia

77 Pages Posted: 1 Jul 2019

See all articles by Ilias Filippou

Ilias Filippou

Washington University in St. Louis - John M. Olin Business School

Mark P. Taylor

Washington University in St. Louis - John M. Olin Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: June 30, 2019

Abstract

We evaluate the cross-sectional predictive ability of a forward-looking monetary policy reaction function, or Taylor rule, in both statistical and economic terms. We find that investors require a premium for holding currency portfolios with high implied interest rates while currency portfolios with low implied rates offer negative currency excess returns. Our forward- looking Taylor rule signals are orthogonal to current nominal interest rates and disconnected from carry trade portfolios and other currency investment strategies. The profitability of the Taylor rule portfolio spread is mainly driven by inflation forecasts rather than the output gap and is robust to data snooping and a wide range of robustness checks.

Keywords: Foreign exchange; currency risk premium; Taylor rules; data snooping bias

JEL Classification: F31, G11, G15

Suggested Citation

Filippou, Ilias and Taylor, Mark Peter, Forward-Looking Policy Rules and Currency Premia (June 30, 2019). Available at SSRN: https://ssrn.com/abstract=3412612 or http://dx.doi.org/10.2139/ssrn.3412612

Ilias Filippou (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Mark Peter Taylor

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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