Forward Exchange Market Transitional Policy Modeling: The Case of the Japanese Yen

This study explores the forward exchange market aspects for the gradual pivot of the Bank of Japan away from its unconventional expansionary monetary policies that depressed interest rates, depreciated the yen, and resisted deflation. This combination permitted the profitable "yen carry trade," where investors borrowed in yen and invested (mainly) in US denominated assets. This study develops a dynamic continuous time model of the forward exchange market for the trading of the Japanese yen and the US dollar to analyze the emergence of a stricter Japanese monetary policy stance with higher interest rates aimed at combating a more inflationary environment.