A new technique for estimating currency premiums
July 30, 2015
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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.
interest rate parity, purchasing power parity, currency premium, misalignment
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