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A Nonlinear Analysis of Forward Premium and Volatility

Author

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  • Hsu Chiente

    (Department of Economics University of Bern)

  • Kugler Peter

    (Department of Economics University of Bern)

Abstract

In this paper we investigate the relationship between risk premium and a time-varying conditional variance of spot rate using weekly Swiss franc/US dollar exchange-rate data. First, we apply an EGARCH-in-mean framework to test the unbiasedness hypothesis of the forward rate with a volatility dependent risk premium. The corresponding estimates point to no significant influence of volatility on the risk premium, and reject the unbiasedness hypothesis. Second, we apply a seminonparametric, nonlinear impulse-response analysis to the spot-rate change and the forward premium. This framework allows us to analyze the risk premium/volatility relationship without using a specific, parametric model such as EGARCH-in-mean. The latter analysis confirms the negative EGARCH-in-mean results with respect to the risk premium/volatility relationship, although the volatility dynamics estimated is clearly different from that implied by the EGARCH estimate. Moreover, the forward premium has a nonlinear dynamic influence on the spot rate, whereas the converse is not true.

Suggested Citation

  • Hsu Chiente & Kugler Peter, 1997. "A Nonlinear Analysis of Forward Premium and Volatility," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 1(4), pages 1-17, January.
    • Handle: RePEc:bpj:sndecm:v:1:y:1997:i:4:n:2
    DOI: 10.2202/1558-3708.1022
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    Cited by:

    1. Clements, Michael P. & Smith, Jeremy, 2001. "Evaluating forecasts from SETAR models of exchange rates," Journal of International Money and Finance, Elsevier, vol. 20(1), pages 133-148, February.

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