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An arbitrage-free Nelson-Siegel term structure model with stochastic volatility for the determination of currency risk premia

Listed author(s):
  • S. Mouabbi

This paper uses a risk-averse formulation of the uncovered interest rate parity to determine exchange rates through interest rate differentials, and ultimately extract currency risk premia. The method proposed consists of developing an affine Arbitrage-Free class of dynamic Nelson-Siegel term structure models with stochastic volatility to obtain the domestic and foreign discount rate variations, which in turn are used to derive a representation of exchange rate depreciations. No-arbitrage restrictions allow to endogenously capturing currency risk premia. Empirical findings suggest that estimated currency risk premia are able to account for the forward premium puzzle and their properties are examined.

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File URL: https://publications.banque-france.fr/sites/default/files/medias/documents/working-paper_527_2014.pdf
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Paper provided by Banque de France in its series Working papers with number 527.

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Length: 53 pages
Date of creation: 2014
Handle: RePEc:bfr:banfra:527
Contact details of provider: Postal:
Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS

Web page: http://www.banque-france.fr/

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