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Was it risk? Or was it fundamentals? Explaining excess currency returns with kernel smoothed regressions

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  • Baillie, Richard T.
  • Kim, Kun Ho

Abstract

This paper uses recently developed kernel smoothing regression procedures and uniform confidence bounds to investigate the forward premium anomaly. These new statistical methods estimate the local time-varying slope coefficient of the regression of spot returns on the lagged interest rate differential. Uniform confidence bands are used to test when uncovered interest parity is violated. The estimated betas in the forward premium smoothed regression are found to vary substantially over time and to be partially explicable in terms of lagged fundamentals and money growth volatilities arising from risk premium. Frequentist model averaging procedures indicate the relative importance of these variables in terms of explaining movements in the betas and hence the apparent causes of regimes where UIP fails.

Suggested Citation

  • Baillie, Richard T. & Kim, Kun Ho, 2015. "Was it risk? Or was it fundamentals? Explaining excess currency returns with kernel smoothed regressions," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 99-111.
    • Handle: RePEc:eee:empfin:v:34:y:2015:i:c:p:99-111
    DOI: 10.1016/j.jempfin.2015.08.007
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    Citations

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    Cited by:

    1. Sakemoto, Ryuta, 2019. "Currency carry trades and the conditional factor model," International Review of Financial Analysis, Elsevier, vol. 63(C), pages 198-208.
    2. Tanujit Dey & Kun Ho Kim & Chae Young Lim, 2018. "Bayesian time series regression with nonparametric modeling of autocorrelation," Computational Statistics, Springer, vol. 33(4), pages 1715-1731, December.
    3. Kim, Kun Ho & Kim, Taejin, 2016. "Capital asset pricing model: A time-varying volatility approach," Journal of Empirical Finance, Elsevier, vol. 37(C), pages 268-281.
    4. Richard T. Baillie & Kun Ho Kim, 2016. "Is Robust Inference with OLS Sensible in Time Series Regressions? Investigating Bias and MSE Trade-offs with Feasible GLS and VAR Approaches," Working Paper series 16-04, Rimini Centre for Economic Analysis.
    5. Charfeddine, Lanouar & Khediri, Karim Ben & Mrabet, Zouhair, 2019. "The forward premium anomaly in the energy futures markets: A time-varying approach," Research in International Business and Finance, Elsevier, vol. 47(C), pages 600-615.
    6. Byrne, Joseph P. & Sakemoto, Ryuta, 2021. "The conditional volatility premium on currency portfolios," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 74(C).
    7. Kim, Kun Ho & Park, Suna, 2016. "Inference and Forecasting Based on the Phillips Curve," KDI Journal of Economic Policy, Korea Development Institute (KDI), vol. 38(2), pages 1-20.
    8. Ok, Hyunmin & Kim, Jinyong & Kim, Yongsik, 2023. "Is the Kimchi premium a speculative bubble?," Finance Research Letters, Elsevier, vol. 57(C).

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    More about this item

    Keywords

    Forward premium anomaly; Local Deviation from Uncovered Interest Parity; Kernel smoothing; Uniform inference; Macroeconomic fundamentals; Frequentist model averaging;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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