On the role of interest rate differentials in the dynamic asymmetry of exchange rates

Hambuckers, Julien; Ulm, Maren

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On the role of interest rate differentials in the dynamic asymmetry of exchange rates

Hambuckers, Julien; Ulm, Maren

2023 • In Economic Modelling, 129

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https://hdl.handle.net/2268/307590

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Keywords :

Exchange rate; interest rate differential; dynamic asymmetry

Abstract :

[en] Motivated by the lack of empirical evidence in favor of the uncovered interest rate parity rule, we revisit the informational content of interest rate differentials (IRD) to explain daily exchange rates variations. Proposing a novel version of a GARCH model, we allow for the IRD to impact on the time-varying conditional asymmetry of the depreciation rate. We find IRD to be a significant factor for the Euro (EUR), the Swiss franc (CHF), the Swedish Krona, the Japanese Yen and the British Pound. These findings empirically support currency crash theories, suggesting that the larger the difference between interest rates, the more likely the high-yield currency appreciates on average but also exhibits greater risk of a large depreciation. Compared to random walk and buy-and-hold benchmarks, we document superior out-of-sample mean returns of a trading rule exploiting IRD information for EUR and CHF.

Disciplines :

International economics

Author, co-author :

Hambuckers, Julien ; Université de Liège - ULiège > HEC Liège : UER > UER Finance et Droit : Finance de Marché

Ulm, Maren ; Université de Liège - ULiège > HEC Liège Research

Language :

English

Title :

On the role of interest rate differentials in the dynamic asymmetry of exchange rates

Publication date :

December 2023

Journal title :

Economic Modelling

ISSN :

0264-9993

eISSN :

1873-6122

Publisher :

Elsevier, Amsterdam, Netherlands

Volume :

129

Peer reviewed :

Peer Reviewed verified by ORBi

Available on ORBi :

since 09 October 2023

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