University of Cambridge > > Cambridge-INET Institute, Faculty of Economics > Uncovered Interest Parity in the short, long and very long run (1 December 2017)

Uncovered Interest Parity in the short, long and very long run (1 December 2017)

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2 Talks:

“Currency Regimes and the Carry Trade ”, David Chambers (JBS, Cambridge)

Abstract: Carry trade returns vary across fixed and floating currency regimes. Over the last century, outsized carry returns occur exclusively in the floating regime, being zero in the fixed regime. The absence of skewness in floating carry returns rules out a skewness-based explanation for this result. Fixed-to-floating regime shifts deliver negative return shocks to the floating carry strategy, even when controlling for volatility risk. This result explains average excess returns to the floating and therefore the unconditional carry trades over the long-run. We rationalize these findings with a model allowing risk compensation in currency markets to depend on regime.

“Exchange Rate Expectations and Risk Premia”, Emile Marin (Faculty of Economics, Cambridge)

Abstract: We present a stylized model of exchange rate determination in segmented financial markets. Exchange rate movements compensate global financiers who intermediate trade but require a risk premium for their services. We show that if exchange rate expectations, as determined by fundamentals in perfect financial markets, follow a stationary autoregressive process, then the model predicts a plausible time profile for the exchange rate risk premium, in line with empirical facts which we document in an extended dataset. In contrast, if exchange rates are expected to follow a random walk, the model predicts that violations to the uncovered interest rate parity condition will be monotonically increasing with the horizon, which is not supported by empirical facts. Finally, we investigate the implications of market structure in financial intermediation and discuss the robustness of our results.

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This event is co-sponsored by the Centre for Financial History.

This talk is part of the Cambridge-INET Institute, Faculty of Economics series.

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