THE COMPARATIVE STATICS OF YIELD SPREAD AND EXCHANGE RATES

This paper investigates how changes in the U.S. yield spread influence the direction of exchange rates. Additionally, it determines whether possibilities for abnormal gains exist in the international monetary market around periods of monetary policy pronouncements by the Federal Reserve Board of the United States. The latter inquiry is pursued only when a secular relationship is seen to exist between the term structure of interest rates and exchange rates. Yield spread is the difference between long bond yield and money market yield. Empirical evidence shows that the British pound sterling maintains a secular relationship with yield spread. This relationship however, is not sufficient to provide opportunities for consistent abnormal returns to speculative investors wishing to capitalize from exchange rate aberrations.