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A Utility Based Comparison of Some Models of Exchange Rate Volatility

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  • Kenneth D. West
  • Hali J. Edison
  • Dongchul Cho

Abstract

When estimates of variances are used to make asset allocation decisions, underestimates of population variances lead to lower expected utility than equivalent overestimates: a utility based criterion is asymmetric, unlike standard criteria such as mean squared error. To illustrate how to estimate a utility based criterion, we use five bilateral weekly dollar exchange rates, 1973-1989, and the corresponding pair of Eurodeposit rates. Of homoskedastic, GARCH, autoregressive and nonpararnetric models for the conditional variance of each exchange rate, GARCI-J models tend to produce the highest utility, on average. A mean squared error criterion also favors GARCH, but not as sharply.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0128.

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Date of creation: Nov 1992
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Publication status: published as Journal of International Economics 1993, vol. 35, no.1, pp. 23-46
Handle: RePEc:nbr:nberte:0128

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  1. Richard A. Meese & Andrew K. Rose, 1989. "An empirical assessment of non-linearities in models of exchange rate determination," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 367, Board of Governors of the Federal Reserve System (U.S.).
  2. Friedman, Benjamin M & Kuttner, Kenneth N, 1992. "Time-Varying Risk Perceptions and the Pricing of Risky Assets," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 566-98, October.
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  11. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, Elsevier, vol. 14(1-2), pages 3-24, February.
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  14. Meltzer, Allan H., 1989. "IMF policy advice, market volatility, commodity price rules, and other essays," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 31(1), pages 1-6, January.
  15. Ippolito, Richard A, 1989. "Efficiency with Costly Information: A Study of Mutual Fund Performance, 1965-1984," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 104(1), pages 1-23, February.
  16. McCulloch, Robert & Rossi, Peter E., 1990. "Posterior, predictive, and utility-based approaches to testing the arbitrage pricing theory," Journal of Financial Economics, Elsevier, Elsevier, vol. 28(1-2), pages 7-38.
  17. Breen, William & Glosten, Lawrence R & Jagannathan, Ravi, 1989. " Economic Significance of Predictable Variations in Stock Index Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 44(5), pages 1177-89, December.
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