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Modeling the horizon-dependent ex-ante risk premium in the foreign exchange market: Evidence from survey data

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  • Prat, Georges
  • Uctum, Remzi

Abstract

Using Consensus Economics survey data on experts’ expectations, we aim to model the 3- and 12-month ahead ex-ante risk premia on the JPY/USD and the GBP/USD exchange markets. For each market and at a given horizon, we show that the risk premium is well determined by the conditional expected variance of the change in the real exchange rate, agents’ real NMP in assets and a constant composite risk aversion coefficient, as suggested by a two-country portfolio asset pricing model. The expected variance depends on the past values of the observed variance and the unobservable real NMP is estimated as a state variable using the Kalman filter methodology. We found that the trends of our estimated horizon-specific NMPs are consistent with the ones of the observed short term aggregate NMPs calculated using the U.S. Treasury International Capital System dataset. Moreover, we show that the ex-post premia tend to adjust toward the ex-ante values, suggesting that experts’ beliefs provide a relevant information to the market. These results bring new responses to the difficulties reported by the widespread ex-post risk premium literature and enhances the usefulness of survey data in modeling the risk premium.

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File URL: http://www.sciencedirect.com/science/article/pii/S1042443112000820
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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Financial Markets, Institutions and Money.

Volume (Year): 23 (2013)
Issue (Month): C ()
Pages: 33-54

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Handle: RePEc:eee:intfin:v:23:y:2013:i:c:p:33-54

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Web page: http://www.elsevier.com/locate/intfin

Related research

Keywords: Risk premium; Foreign exchange market; International asset pricing model; Survey data;

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Cited by:
  1. Georges Prat, 2012. "Equity risk premium and time horizon: what do the U.S. secular data say?," Working Papers 12-06, Association Française de Cliométrie (AFC).

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