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Recent Estimates of Time-Variation in the Conditional Variance and in the Exchange Risk Premium

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  • Jeffrey A. Frankel.

Abstract

The optimal-diversification model of investors' portfolio behavior can give a linear relationship between the exchange risk premium and the conditional exchange rate variance. This note surveys recent empirical work that allows for the conditional variance itself, and therefore the risk premium, to vary over time. In particular, it examines the implications of recent empirical estimates for earlier arguments, based on the assumption that the conditional variance was constant over time, that the exchange risk premium had to be small in magnitude and variability.

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Bibliographic Info

Paper provided by University of California at Berkeley in its series Economics Working Papers with number 8866.

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Date of creation: 01 Jan 1988
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Handle: RePEc:ucb:calbwp:8866

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Postal: University of California at Berkeley, Berkeley, CA USA
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References

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  1. Jeffrey A. Frankel & Richard Meese, 1987. "Are Exchange Rates Excessively Variable?," NBER Working Papers 2249, National Bureau of Economic Research, Inc.
  2. Engel, Charles & Rodrigues, Anthony P, 1989. "Tests of International CAPM with Time-Varying Covariances," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 4(2), pages 119-38, April-Jun.
  3. Francis X. Diebold & Marc Nerlove, 1986. "The dynamics of exchange rate volatility: a multivariate latent factor ARCH model," Special Studies Papers 205, Board of Governors of the Federal Reserve System (U.S.).
  4. Frankel, Jeffrey A., 1982. "In search of the exchange risk premium: A six-currency test assuming mean-variance optimization," Journal of International Money and Finance, Elsevier, vol. 1(1), pages 255-274, January.
  5. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  6. Richard K. Lyons, 1986. "Tests of the foreign exchange risk premium using the expected second moments implied by option pricing," International Finance Discussion Papers 290, Board of Governors of the Federal Reserve System (U.S.).
  7. Robert E. Cumby & Maurice Obstfeld, 1984. "International Interest Rate and Price Level Linkages under Flexible Exchange Rates: A Review of Recent Evidence," NBER Chapters, in: Exchange Rate Theory and Practice, pages 121-152 National Bureau of Economic Research, Inc.
  8. Robert J. Hodrick & Sanjay Srivastava, 1985. "The Covariation of Risk Premiums and Expected Future Spot Exchange Rates," NBER Working Papers 1749, National Bureau of Economic Research, Inc.
  9. Giovannini, Alberto & Jorion, Philippe, 1987. "Interest rates and risk premia in the stock market and in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 6(1), pages 107-123, March.
  10. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  11. Bilson, John F O, 1985. "Macroeconomic Stability and Flexible Exchange Rates," American Economic Review, American Economic Association, vol. 75(2), pages 62-67, May.
  12. Domowitz, Ian & Hakkio, Craig S., 1985. "Conditional variance and the risk premium in the foreign exchange market," Journal of International Economics, Elsevier, vol. 19(1-2), pages 47-66, August.
  13. Garman, Mark B. & Kohlhagen, Steven W., 1983. "Foreign currency option values," Journal of International Money and Finance, Elsevier, vol. 2(3), pages 231-237, December.
  14. Hsieh, David A., 1984. "Tests of rational expectations and no risk premium in forward exchange markets," Journal of International Economics, Elsevier, vol. 17(1-2), pages 173-184, August.
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