Affine Term Structure Models for the Foreign Exchange Risk Premium PDF Download
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Author: Luca Benati
Publisher:
ISBN:
Category :
Languages : en
Pages : 40
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Book Description
This paper uses two affine term structure models from the Duffie-Kan class - a three-factor Cox-Ingersoll-Ross model, and a three-factor model in the spirit of Longstaff and Schwartz - to extract historical estimates of foreign exchange risk premia for the pound with respect to the US dollar. The term structures of interest rates for the two countries are estimated jointly, together with the dynamics of the nominal exchange rates between them, via maximum likelihood. The likelihood function is computed via the Kalman filter, and is maximised numerically with respect to unknown parameters. Particular attention is paid to the robustness of the results across models; to the overall (filter plus parameter) econometric uncertainty associated with risk premia estimates; and to the ability of estimated structures to replicate Fama's quot;forward discount anomaly.quot; The paper's main results may be summarised as follows. First, risk premia estimates are not consistent across the two models. Second, both models fail to replicate the forward discount anomaly, with theoretical values of amp;β in the Fama regressions implied by estimated structures being consistently positive at all horizons from 1 to 12 months.
Author: Luca Benati
Publisher:
ISBN:
Category :
Languages : en
Pages : 40
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Book Description
This paper uses two affine term structure models from the Duffie-Kan class - a three-factor Cox-Ingersoll-Ross model, and a three-factor model in the spirit of Longstaff and Schwartz - to extract historical estimates of foreign exchange risk premia for the pound with respect to the US dollar. The term structures of interest rates for the two countries are estimated jointly, together with the dynamics of the nominal exchange rates between them, via maximum likelihood. The likelihood function is computed via the Kalman filter, and is maximised numerically with respect to unknown parameters. Particular attention is paid to the robustness of the results across models; to the overall (filter plus parameter) econometric uncertainty associated with risk premia estimates; and to the ability of estimated structures to replicate Fama's quot;forward discount anomaly.quot; The paper's main results may be summarised as follows. First, risk premia estimates are not consistent across the two models. Second, both models fail to replicate the forward discount anomaly, with theoretical values of amp;β in the Fama regressions implied by estimated structures being consistently positive at all horizons from 1 to 12 months.
Author: Nikolaos Panigirtzoglou
Publisher:
ISBN:
Category :
Languages : en
Pages : 19
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Book Description
This paper uses affine models of the term structure to provide historical estimates of risk premia. The foreign exchange and inflation risk premia can be modelled in the same way since the price level can be thought of as an exchange rate that transforms real prices to nominal prices. Affine models with three latent factors of the Cox, Ingersoll and Ross (1985) type are used, with a common factor between the two pricing kernels (state price vectors) to account for interdependence. In the case of foreign exchange risk premium two factors are used to model the domestic pricing kernel and two factors to model the foreign pricing kernel with a common factor between them. This specification can account for the forward premium anomaly, the tendency for high interest rate currencies to appreciate, which contradicts uncovered interest rate parity. In the case of inflation risk premium two factors are used to model the real pricing kernel and two factors to model the nominal pricing kernel with a common factor between them. The model distinguishes between expected and realised variables and therefore allows the estimation of expectational errors. The model also allows for time-varying market prices of risk and time-varying correlations between the two pricing kernels or between each of the pricing kernels and the foreign exchange rate or the price level. Another contribution, which has been ignored in the previous literature, is that the model is estimated using both bond yields and realised price level or foreign exchange rate changes. Fitting the later is necessary for the model to produce realistic patterns for the price level or foreign exchange rate changes. The results show that the foreign exchange risk premium fell substantially after 96, which is consistent with the large appreciation of sterling. Expectational errors were very large for the whole of the period studied, that is, from 93 to 99. Inflation risk premium was about 100 basis points for most of the period 87 to 97, but fell substantially since Bank independence in March 97, which may be the result of a higher credibility to the new UK monetary policy institutional framework. Inflation expectational errors also became smaller after the adoption of inflation targeting in UK in January 93.
Author: Lucio Sarno
Publisher:
ISBN:
Category : Foreign exchange rates
Languages : en
Pages : 0
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Book Description
We study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, defined as the tendency of high-interest rate currencies to appreciate rather than depreciate. These risk premiums arise endogenously from the no-arbitrage condition relating the term structure of interest rates and exchange rates. Estimating affine (multi-currency) term structure models reveals a noticeable tradeoff between matching depreciation rates and accuracy in pricing bonds. Risk premiums implied by our global affine model generate unbiased predictions for currency excess returns and are closely related to global risk aversion, the business cycle, and traditional exchange rate fundamentals.
Author: Antonio Diez de los Rios
Publisher:
ISBN:
Category : Foreign exchange rates
Languages : en
Pages : 43
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Book Description
Author: Lucio Sarno
Publisher:
ISBN:
Category :
Languages : en
Pages : 86
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Book Description
We study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, defined as the tendency of high-interest rate currencies to appreciate rather than depreciate. These risk premiums arise endogenously from the no-arbitrage condition relating the term structure of interest rates and exchange rates. Estimating affine (multi-currency) term structure models reveals a noticeable tradeoff between matching depreciation rates and accuracy in pricing bonds. Risk premiums implied by our global affine model generate unbiased predictions for currency excess returns and are closely related to global risk aversion, the business cycle, and traditional exchange rate fundamentals.
Author: Dennis Bams
Publisher:
ISBN:
Category : Affine algebraic groups
Languages : en
Pages : 54
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Book Description
Author: Mario Alessandro Maggi
Publisher:
ISBN:
Category :
Languages : en
Pages : 116
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Book Description
Author: David Backus
Publisher:
ISBN:
Category : Foreign exchange rates
Languages : en
Pages : 64
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Book Description
Perhaps the most puzzling feature of currency prices is the tendency for high interest rate currencies to appreciate, when the expectations hypothesis suggests the reverse. Some have attributed this forward premium anomaly to a time-varying risk premium, but theory has been largely unsuccessful in producing a risk premium with the requisite properties. We characterize the risk premium in a general arbitrage-free setting and describe the features a theory must have to account for the anomaly. In affine models, the anomaly requires either that state variables have asymmetric effects on state prices in different currencies or that we abandon the common requirement that interest rates be strictly positive.
Author:
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
We propose a multi-currency quadratic term structure model that allows for several sources of market incompleteness. A new feature of the model is the jump-quadratic dynamics of the exchange rates that simultaneously generate greater flexibility in the time-varying risk premium and excessive currency volatility. Our model empirically outperforms the complete market quadratic and affine multi-currency diffusion models. It accounts for the forward premium anomaly with reasonable market price of risks. The market incompleteness consists of idiosyncratic diffusion-like innovations and jump discontinuities. We find that the jumps dominate the variations in the currency returns and produce most of the excessive currency volatility.
Author: Mr.Tigran Poghosyan
Publisher: International Monetary Fund
ISBN: 1455209554
Category : Business & Economics
Languages : en
Pages : 26
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Book Description
This paper analyzes macroeconomic determinants of the foreign exchange risk premium in two Gulf Cooperation Council (GCC) countries that peg their currencies to the U.S. dollar: Saudi Arabia and the United Arab Emirates. The analysis is based on the stochastic discount factor methodology, which imposes a no arbitrage condition on the relationship between the foreign exchange risk premium and its macroeconomic determinants. Estimation results suggest that U.S. inflation and consumption growth are important factors driving the risk premium, which is in line with the standard C-CAPM model. In addition, growth in international oil prices influences the risk premium, reflecting the important role played by the hydrocarbon sector in GCC economies. The methodology employed in this paper can be used for forecasting the risk premium on a monthly basis, which has important practical implications for policymakers interested in the timely monitoring of risks in the GCC.
