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Forward-Looking Policy Rules and Currency Premia

Author

Listed:
  • Taylor, Mark
  • Filippou, Ilias
Abstract
We evaluate the cross-sectional predictive ability of a forward-looking monetary policy reaction function, or Taylor rule, in both statistical and economic terms. We find that investors require a premium for holding currency portfolios with high implied interest rates while currency portfolios with low implied rates offer negative currency excess returns. Our forward-looking Taylor rule signals are orthogonal to current nominal interest rates and disconnected from carry trade portfolios and other currency investment strategies. The profitability of the Taylor rule portfolio spread is mainly driven by inflation forecasts rather than the output gap and is robust to data snooping and a wide range of robustness checks.

Suggested Citation

  • Taylor, Mark & Filippou, Ilias, 2019. "Forward-Looking Policy Rules and Currency Premia," CEPR Discussion Papers 13835, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:13835
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    More about this item

    Keywords

    Foreign exchange; Currency risk premium; Taylor rules; Data snooping bias;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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