Political vs. Currency Premia in International Real Interest Differentials: A Study of Forward Rates for 24 Countries

Abstract

Different approaches to quantifying the degree of capital mobility for a cross-section of currencies --particularly saving-investment corre- lations and tests of real interest parityhave appeared to show a surprisingly low degree of financial market integration. We use a new data set, forward rate data for 24 countries, including many small industrialized countries and seven LDCs, to decompose the real Interest differential into two parts: the covered interest differential, or political premium, and the real forward discount, or currency premium. The latter In turn can be decomposed into the exchange risk premium and expected real depreciation.