A Latent Factor Model of European Exchange Rate Risk Premia
AbstractThe floating of a number of European currencies in 1992-93 created a new body of data on foreign exchange risk premia, or deviations from uncovered interest rate parity (UIP). In this paper, excess returns to investments in SEK, NOK, FIM, GBP, ITL and ESP against the DEM are investigated. First, univariate GARCH-M models are estimated for each currency and UIP is tested. UIP fares as badly on this data set as in most other studies. Then a latent factor GARCH model that takes common effects in the different currency markets into account is applied. The risk premia are modelled as functions of time varying factor variances. A Kalman filter is used to identify the unobservable risk factors. A one-factor model that allows for idiosyncratic risk seem to fit the data quite well. However, the puzzling finding is made that the factor risk does not appear to be priced. Copyright @ 1999 by John Wiley & Sons, Ltd. All rights reserved.
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Bibliographic InfoArticle provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.
Volume (Year): 4 (1999)
Issue (Month): 3 (July)
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Web page: http://www.interscience.wiley.com/jpages/1076-9307/
Other versions of this item:
- Alexius, Annika & Sellin, Peter, 1997. "A Latent Factor Model of European Exchange Rate Risk Premia," Working Paper Series in Economics and Finance 156, Stockholm School of Economics.
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
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- Herrmann, Sabine & Jochem, Axel, 2003. "Die internationale Intregration der Devisenmärkte in den mittel- und osteuropäischen Beitrittsländern: Spekulative Effizienz, Transaktionskosten und Wechselkursprämien," Discussion Paper Series 1: Economic Studies 2003,08, Deutsche Bundesbank, Research Centre.
- Alexius, Annika, 2002. "Can Endogenous Monetary Policy Explain the Deviations from UIP," Working Paper Series 2002:17, Uppsala University, Department of Economics.
- Chang, Kook-Hyun & Kim, Myung-Jig, 2001. "Jumps and time-varying correlations in daily foreign exchange rates," Journal of International Money and Finance, Elsevier, vol. 20(5), pages 611-637, October.
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