Affine Models of the Joint Dynamics of Exchange Rates and Interest Rates

47 Pages Posted: 21 Jun 2003

See all articles by Bing Han

Bing Han

University of Calgary - Haskayne School of Business

Peter J. Hammond

Department of Economics, University of Warwick; Stanford University

Date Written: June 15, 2003

Abstract

This paper addresses issues in extending the affine class of term structure models to describe the joint dynamics of exchange rates and interest rates. A standard incomplete markets approach is shown to impose many constraints on exchange rate dynamics in affine settings. A canonical multicountry affine model, and the method to estimate it via Kalman filters, are formulated. Familiar difficulties in reconciling the forward premium anomaly with affine models are overcome, by introducing additional state variables which affect only exchange-rate dynamics. This yields a more adequate model of the observed volatilities of exchange rates and their correlation with interest rates.

JEL Classification: G15, C32, F31

Suggested Citation

Han, Bing and Hammond, Peter J., Affine Models of the Joint Dynamics of Exchange Rates and Interest Rates (June 15, 2003). Available at SSRN: https://ssrn.com/abstract=407703 or http://dx.doi.org/10.2139/ssrn.407703

Bing Han (Contact Author)

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
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403-220-7825 (Phone)
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Peter J. Hammond

Department of Economics, University of Warwick ( email )

Gibbet Hill Road
Coventry, CV4 7AL
United Kingdom
(0) 24765 23052 (Phone)
(0) 24765 23032 (Fax)

HOME PAGE: http://www.stanford.edu/~hammond/

Stanford University ( email )

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United States
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HOME PAGE: http://www.stanford.edu/people/hammond

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