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The Intertemporal Relation between Expected Return and Risk on Currency

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Author Info
Turan Bali () (Baruch College)
Kamil Yilmaz

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Abstract

The literature has so far focused on the risk-return tradeoff in equity markets and ignored alternative risky assets. This paper is the first to examine the presence and significance of an intertemporal relation between expected return and risk in the foreign exchange market. The paper provides new evidence on the intertemporal capital asset pricing model by using high-frequency intraday data on currency and by presenting significant time-variation in the risk aversion parameter. Five-minute returns on the spot exchange rates of the U.S. dollar vis-à-vis six major currencies (the Euro, Japanese Yen, British Pound Sterling, Swiss Franc, Australian Dollar, and Canadian Dollar) are used to test the existence and significance of a daily risk-return tradeoff in the FX market based on the GARCH, realized, and range volatility estimators. The results indicate a positive, but statistically weak relation between risk and return on currency.

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Paper provided by TUSIAD-Koc University Economic Research Forum in its series TÜSİAD-Koç University Economic Research Forum Working Papers with number 0909.

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Length: 39 pages
Date of creation: Sep 2009
Date of revision:
Handle: RePEc:koc:wpaper:0909

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Related research
Keywords: Foreign exchange market; ICAPM; High-frequency data; Time-varying risk aversion; Daily realized volatility;

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Estimation
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions

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