Currency and credit markets

In this paper, we focus on two aspects of the relationship between exchange rates and interest rates, which have not been widely discussed. First, the extent to which the forward premia/discount in one market can be used to predict the speculative return in the other. Second, the extent to which unanticipated changes in the speculative returns are correlated across markets so that positions in one market can be hedged using positions in the other. Our results demonstrate that these two linkages are also important factors behind the time variation in speculative risk premia. (c) 2007 Elsevier Ltd. All rights reserved.