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Asset price based estimates of sterling exchange rate risk premia

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  • Groen, Jan J.J.
  • Balakrishnan, Ravi

Abstract

In this paper we report estimates of the effective sterling, sterling/Deutsche mark and sterling/US dollar risk premia over a monthly 1987-2001 sample, generated using a conditional factor model for the stochastic discount factor of a representative 'worldwide' investor. The model relates this stochastic discount factor to the real return on a 'worldwide' stock portfolio, with the model parameters varying with variations in the slope of the 'world' term structure of interest rates. Econometric tests indicate that this model is accepted by the data. The corresponding parameter estimates are used to compute the risk premium for the three aforementioned sterling exchange rates. A graphical analysis indicates that, in terms of magnitude, our measure of the exchange rate risk premium is mainly of importance for the sterling/Deutsche mark exchange rate. Risk-adjusted test regressions for uncovered interest rate parity vis-`a-vis the major European currencies provide some confirmation for this.
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  • Groen, Jan J.J. & Balakrishnan, Ravi, 2006. "Asset price based estimates of sterling exchange rate risk premia," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 71-92, February.
  • Handle: RePEc:eee:jimfin:v:25:y:2006:i:1:p:71-92
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    Cited by:

    1. Mr. Ravi Balakrishnan & Mr. Volodymyr Tulin, 2006. "U.S. Dollar Risk Premiums and Capital Flows," IMF Working Papers 2006/160, International Monetary Fund.
    2. Gábor Regős & Xibin Zhang, 2015. "Modeling the exchange rate using price levels and country risk," Cogent Economics & Finance, Taylor & Francis Journals, vol. 3(1), pages 1056928-105, December.
    3. Al-Shboul, Mohammad & Anwar, Sajid, 2014. "Time-varying exchange rate exposure and exchange rate risk pricing in the Canadian Equity Market," Economic Modelling, Elsevier, vol. 37(C), pages 451-463.
    4. Adrian, Tobias & Etula, Erkko & Groen, Jan J.J., 2011. "Financial amplification of foreign exchange risk premia," European Economic Review, Elsevier, vol. 55(3), pages 354-370, April.
    5. Bartram, Söhnke M. & Bodnar, Gordon M., 2012. "Crossing the lines: The conditional relation between exchange rate exposure and stock returns in emerging and developed markets," Journal of International Money and Finance, Elsevier, vol. 31(4), pages 766-792.
    6. Hassan Shareef & Santhakumar Shijin, 2016. "Expectations Hypothesis and Term Structure of Interest Rates: An Evidence from Emerging Market," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 23(2), pages 137-152, June.
    7. Angelo Ranaldo & Paul Söderlind, 2010. "Safe Haven Currencies," Review of Finance, European Finance Association, vol. 14(3), pages 385-407.
    8. Luca Benati, 2006. "Affine term structure models for the foreign exchange risk premium," Bank of England working papers 291, Bank of England.
    9. Jun Nagayasu, 2011. "The Common Component in Forward Premiums: Evidence from the Asia–Pacific Region," Review of International Economics, Wiley Blackwell, vol. 19(4), pages 750-762, September.
    10. Robert Kelm, 2010. "The Exchange Rate and Two Price Inflations in Poland in the Period 1999-2009. Do Globalization and Balassa-Samuelson Effect Matter?," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 2(4), pages 315-349, September.

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