Predicting risk premia in short-term interest rates and exchange rates

Arbeitspapier

We assess the ability of yield curve factors to predict risk premia in short-term interest rates and exchange rates across a large sample of major advanced economies. We find that the same tick-shaped linear combination of (relative) bond yields predicts risk premia in both short-term interest rates and exchange rates at returnforecasting horizons of up to six months for all (but one) countries and currencies in our sample. Our single forecasting factor loads positively on the short and long end of the curve and negatively on the medium-term and is therefore inversely related to Nelson-Siegel's curvature factor. In line with recent interpretations of the yield curve factors, our findings suggest that the hump of the yield curve bears important information about future short-term interest rates. A relatively high curvature predicts a surprise rise in short-term interest rates beyond expectations and, coincidentally, an appreciation of the home currency in line with uncovered interest rate parity.

Object Details

• ISBN: 978-92-899-3236-3
• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 2131

Classification and Topics

• Classification: Wirtschaft ; Single Equation Models; Single Variables: Panel Data Models; Spatio-temporal Models ; Forecasting Models; Simulation Methods ; Portfolio Choice; Investment Decisions
• Subject: Exchange rates ; Interest rates ; Risk premia ; Yield curve ; Predictability

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Gräb, Johannes ; Kostka, Thomas
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2018

Further information

• DOI: doi:10.2866/298754
• Handle: http://hdl.handle.net/10419/179346
• Last update: 10.03.2025, 11:41 AM CET