A new technique for estimating currency premiums

July 30, 2015
Kei Imakubo^*1
Koichiro Kamada^*2
Kazutoshi Kan^*3

Abstract

This paper extends the model of currency premiums developed by Clarida (2012, 2013). In our extended model, a currency premium consists of two disequilibrium factors: One is the interest rate gap, i.e., the deviation of real interest rates, domestic and foreign, from their equilibrium values; the other is the exchange rate misalignment, i.e., the deviation of real exchange rates from their equilibrium values. This paper calculates these disequilibrium factors included in the dollar, euro, and yen, and shows empirically the developments of the currency premiums from the mid-2000s. The result indicates that the euro was growing to become a world currency next to the US dollar toward the late 2000s, and then the yen was preferred as a safe haven while the US and European capital markets were under stresses.

JEL Classifications
F31, F37

Keywords
interest rate parity, purchasing power parity, currency premium, misalignment

We would like to thank the staff of the Bank of Japan for their helpful comments. The opinions expressed here, as well as any remaining errors, are those of the authors and should not be ascribed to the Bank of Japan.

*1 Monetary Affairs Department, Bank of Japan
E-mail : kei.imakubo@boj.or.jp
*2 Monetary Affairs Department, Bank of Japan (currently Institute for Monetary and Economic Studies)
E-mail : kouichirou.kamada@boj.or.jp
*3 Monetary Affairs Department, Bank of Japan
E-mail : kazutoshi.kan@boj.or.jp

Notice

Papers in the Bank of Japan Working Paper Series are circulated in order to stimulate discussion and comments. Views expressed are those of authors and do not necessarily reflect those of the Bank.
If you have any comment or question on the working paper series, please contact each author.
When making a copy or reproduction of the content for commercial purposes, please contact the Public Relations Department (post.prd8@boj.or.jp) at the Bank in advance to request permission. When making a copy or reproduction, the source, Bank of Japan Working Paper Series, should explicitly be credited.