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Neglected Common Factors in Exchange Rate Volatility

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Author Info

  • Ronald Mahieu
  • Peter Schotman

Abstract

The paper proposes a new multivariate model for exchange rate volatility in a system of bilateral exchange rates, using a factor structure of exchange rates one of the common factors is always related to the numeraire currency. Time variation in the volatility is modelled using a stochastic variance approach. The interpretation of the factors provides a new way of estimating risk premia in the foreign exchange market. Empirical results show considerable volatility spillovers among the four major currencies. Risk premia show a major sign reversal for the dollar risk premium around 1978.

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Bibliographic Info

Paper provided by European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ in its series CEPR Financial Markets Paper with number 0041.

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Date of creation: Jan 1994
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Availability: in print
Handle: RePEc:cpr:ceprfm:0041

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Related research

Keywords: Stochastic Volatility; Exchange Rates; Factor Models; Risk Efficiency; Competitive Market Making; Rational Expectations;

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  1. Bekaert, Geert & Hodrick, Robert J., 1993. "On biases in the measurement of foreign exchange risk premiums," Journal of International Money and Finance, Elsevier, vol. 12(2), pages 115-138, April.
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