Do relative yield factors help predict PH-US exchange rate movements?
Date
2013-10
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Abstract
This paper carries out an empirical analysis on the predictability of exchange rate movements using information derived from the term structure of interest rates or yield curve. The empirical proxies of three relative yield curve factors. namely level, slope, and curvature, are estimated using Philippine and US data on actively traded bonds at different maturities between 2002 and 2011. All relative yield curve factors are significant (at 99 percent significance level) in predicting exchange rate movements at 6- and 12-month horizons. Results show that a one percent increase in the relative slope factor, implying a steepening of the US yield curve relative to the Philippine yield curve, predicts annualized depreciation of the Philippine peso (or equivalently, relative flattening of the Philippine yield curve )over the next 6 and 12 months. The power of the three relative factors to predict changes in excess currency returns proves its significance also at 6- and 12-month horizons. Lastly, results show that the model performs better than random walk in forecasting exchange rate movements at 1- and 6-month horizons.
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Keywords
Exchange rate, Peso, Dollar