Bond Convenience Yields and Exchange Rate Dynamics

摘要

This paper proposes a new model of exchange rate determination that is consistent not only with the long-standing classic UIP puzzle, but also with the more recent evidence that UIP violations reverse direction at longer horizons, which has important implications about the underlying exchange rate behavior. The model relies on endogenous fluctuations in equilibrium bond convenience yields. Nonzero equilibrium currency returns arise as compensation for differences in the convenience yields between bonds denominated in different currencies. When the home convenience yield is relatively low, both domestic interest rates and excess currency returns are high, as domestic and international investors require higher compensation to hold domestic debt.