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More evidence on the dollar risk premium in the foreign exchange market

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  • Bams, Dennis
  • Walkowiak, Kim
  • Wolff, Christian C. P.

Abstract

In this article, we develop and estimate an econometric panel data model to capture the common dynamics in dollar risk premia in various forward foreign exchange rates. The common component in the dollar risk premia is highly significant and embodies a common pattern of positive serial correlation (persistence) for the pound, the yen and the mark. Interestingly, our results indicate that the dynamics of the forward prediction error can be attributed almost exclusively to this dollar-related common component. Our evidence also suggests that the three different foreign currencies’ dollar risk premia ‘respond’ to the common factor to different degrees.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 23 (2004)
Issue (Month): 2 (March)
Pages: 271-282

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Handle: RePEc:eee:jimfin:v:23:y:2004:i:2:p:271-282

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Web page: http://www.elsevier.com/locate/inca/30443

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References

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  1. Boozer, Michael A., 1997. "Econometric Analysis of Panel Data Badi H. Baltagi Wiley, 1995," Econometric Theory, Cambridge University Press, vol. 13(05), pages 747-754, October.
  2. Hodrick, Robert J., 1981. "International asset pricing with time-varying risk premia," Journal of International Economics, Elsevier, vol. 11(4), pages 573-587, November.
  3. Baillie, Richard T. & Bollerslev, Tim, 2000. "The forward premium anomaly is not as bad as you think," Journal of International Money and Finance, Elsevier, vol. 19(4), pages 471-488, August.
  4. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  5. Huisman, Ronald & Koedijk, Kees & Kool, Clemens & Nissen, Francois, 1998. "Extreme support for uncovered interest parity," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 211-228, February.
  6. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  7. Charles Engel, 1995. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
  8. Nijman, T.E. & Palm, F.C. & Wolff, C.C.P., 1991. "Premia in Forward Foreign Exchange as Unobserved Components," Papers 9112, Tilburg - Center for Economic Research.
  9. Geert Bekaert & Robert J. Hodrick, 1991. "Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," NBER Working Papers 3790, National Bureau of Economic Research, Inc.
  10. Nijman, Theo E & Palm, Franz C & Wolff, Christian C P, 1993. "Premia in Forward Foreign Exchange as Unobserved Components: A Note," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(3), pages 361-65, July.
  11. Mahieu, Ronald & Schotman, Peter, 1994. "Neglected common factors in exchange rate volatility," Journal of Empirical Finance, Elsevier, vol. 1(3-4), pages 279-311, July.
  12. Koedijk, Kees G. & Schotman, Peter, 1990. "How to beat the random walk : An empirical model of real exchange rates," Journal of International Economics, Elsevier, vol. 29(3-4), pages 311-332, November.
  13. Wolff, Christian C P, 1987. " Forward Foreign Exchange Rates, Expected Spot Rates, and Premia: A Signal-Extraction Approach," Journal of Finance, American Finance Association, vol. 42(2), pages 395-406, June.
  14. Eric Zivot, 1998. "Cointegration and Forward and Spot Exchange Rate Regressions," Econometrics 9812001, EconWPA.
  15. Lewis, Karen K., 1995. "Puzzles in international financial markets," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 37, pages 1913-1971 Elsevier.
  16. Wolff, Christian C. P., 2000. "Measuring the forward foreign exchange risk premium: multi-country evidence from unobserved components models," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 10(1), pages 1-8, January.
  17. Zivot, Eric, 2000. "Cointegration and forward and spot exchange rate regressions," Journal of International Money and Finance, Elsevier, vol. 19(6), pages 785-812, December.
  18. Koedijk, C.G. & Schotman, P., 1990. "How to beat the random walk: An empirical model of real exchange rates," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3108720, Tilburg University.
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Citations

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Cited by:
  1. Pierre Perron† & Tatsuma Wada, 2005. "Let’s Take a Break: Trends and Cycles in US Real GDP?," Boston University - Department of Economics - Working Papers Series WP2005-031, Boston University - Department of Economics, revised Oct 2005.
  2. Tobias Adrian & Erkko Etula & Jan J. J. Groen, 2010. "Financial amplification of foreign exchange risk premia," Staff Reports 461, Federal Reserve Bank of New York.
  3. Jan J J Groen & Ravi Balakrishnan, 2005. "Asset price based estimates of sterling exchange rate risk premia," Bank of England working papers 250, Bank of England.
  4. Menkhoff, Lukas & Rebitzky, Rafael R. & Schröder, Michael, 2009. "Heterogeneity in exchange rate expectations: Evidence on the chartist-fundamentalist approach," Journal of Economic Behavior & Organization, Elsevier, vol. 70(1-2), pages 241-252, May.
  5. Chakraborty, Avik, 2009. "Learning, The Forward Premium Puzzle, And Market Efficiency," Macroeconomic Dynamics, Cambridge University Press, vol. 13(S1), pages 31-57, May.
  6. Zhiguang Wang & Prasad Bidarkota, 2012. "Risk premia in forward foreign exchange rates: a comparison of signal extraction and regression methods," Empirical Economics, Springer, vol. 42(1), pages 21-51, February.
  7. Murphy, Austin, 2008. "An empirical investigation of investor expectations in the currency market," International Review of Financial Analysis, Elsevier, vol. 17(1), pages 108-133.

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