This paper is an empirical investigation of the predictability and comovement of risk premia in the term structure of Euromarket interest rates. We show that variables which have been used as proxies for risk premia on uncovered foreign asset positions also predict excess returns in Euroniarket term structures, while variables which have been used as proxies for risk premia in the term structure also predict excess returns on taking uncovered foreign asset positions. These findings suggests that risk premia in the Euromarket term structures and on uncovered foreign asset positions move together. We test formally the hypothesis that risk premia on uncovered 3-month EuroDM and Eurosterling deposits move in proportion to a single latent variable. We are unable to reject this hypothesis. We are also unable to reject the hypothesis that the risk premia on these three strategies and those on rolling over 1-month Eurosterling (EuroDM) deposits versus holding a 3-month Eurosterlirig (EuroDN) deposit move in proportion to a single latent variable. The single latent variable model can be interpreted atheoretically, as a way of characterizing the extent to which predictable asset returns "move together"; or it can be interpreted as in Hansen and Hodrick (1983) and Hodrick and Srivastava (1983) as a specialization of the ICAPM in which assets have constant betas on a single, unobservable benchmark portfolio.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
1946.
Length: Date of creation: Mar 1987 Date of revision: Handle: RePEc:nbr:nberwo:1946
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Pavlova, Anna & Rigobon, Roberto, 2004.
"Asset Prices and Exchange Rates,"
Working papers
4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
[Downloadable!]
Other versions:
Pavlova, Anna & Rigobon, Roberto, 2003.
"Asset Prices and Exchange Rates,"
Working papers
4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
[Downloadable!]