DP13252-3 | International yield curves and currency puzzles

Publication Date

10/17/2018

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Abstract

The depreciation rate is often computed as the ratio of foreign and domestic pricing kernels. Using bond prices to estimate these kernels leads to currency puzzles: inability of models to match violations of the uncovered interest parity and volatility of exchange rates. One cannot use information in bonds alone because exchange rates are not spanned by bonds. This view of the puzzles is distinct from market incompleteness. Incorporating exchange rates into estimation of yield curve models helps with resolving the puzzles. It also allows to connect the differences between international yield curves to characteristics of exchange rates.