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Asset price based estimates of sterling exchange rate risk premia

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  • Jan J J Groen
  • Ravi Balakrishnan

Abstract

In this paper we report estimates of the effective sterling, sterling/Deutsche mark and sterling/US dollar risk premia over a monthly 1987-2001 sample, generated using a conditional factor model for the stochastic discount factor of a representative 'worldwide' investor. The model relates this stochastic discount factor to the real return on a 'worldwide' stock portfolio, with the model parameters varying with variations in the slope of the 'world' term structure of interest rates. Econometric tests indicate that this model is accepted by the data. The corresponding parameter estimates are used to compute the risk premium for the three aforementioned sterling exchange rates. A graphical analysis indicates that, in terms of magnitude, our measure of the exchange rate risk premium is mainly of importance for the sterling/Deutsche mark exchange rate. Risk-adjusted test regressions for uncovered interest rate parity vis-`a-vis the major European currencies provide some confirmation for this.

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Paper provided by Bank of England in its series Bank of England working papers with number 250.

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Date of creation: Feb 2005
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Handle: RePEc:boe:boeewp:250

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Citations

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Cited by:
  1. Adrian, Tobias & Etula, Erkko & Groen, Jan J.J., 2011. "Financial amplification of foreign exchange risk premia," European Economic Review, Elsevier, vol. 55(3), pages 354-370, April.
  2. Robert Kelm, 2010. "The Exchange Rate and Two Price Inflations in Poland in the Period 1999-2009. Do Globalization and Balassa-Samuelson Effect Matter?," Central European Journal of Economic Modelling and Econometrics, CEJEME, vol. 2(4), pages 315-349, September.
  3. Angelo Ranaldo & Paul Söderlind, 2007. "Safe Haven Currencies," University of St. Gallen Department of Economics working paper series 2007 2007-22, Department of Economics, University of St. Gallen.
  4. Bartram, Sohnke M. & Bodnar, Gordon M., 2006. "Crossing the Lines: The Conditional Relation between Exchange Rate Exposure and Stock Returns in Emerging and Developed Markets," MPRA Paper 13064, University Library of Munich, Germany, revised 02 Nov 2008.
  5. Luca Benati, 2006. "Affine term structure models for the foreign exchange risk premium," Bank of England working papers 291, Bank of England.
  6. Nagayasu, Jun, 2010. "The Common Component in the Forward Premium: Evidence from the Asia-Pacific Region," MPRA Paper 24549, University Library of Munich, Germany.
  7. Ravi Balakrishnan & Volodymyr Tulin, 2006. "U.S. Dollar Risk Premiums and Capital Flows," IMF Working Papers 06/160, International Monetary Fund.
  8. Al-Shboul, Mohammad & Anwar, Sajid, 2014. "Time-varying exchange rate exposure and exchange rate risk pricing in the Canadian Equity Market," Economic Modelling, Elsevier, vol. 37(C), pages 451-463.

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