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Interest Rate Arbitrage in Currency Baskets; Forecasting Weights and Measuring Risk

  • Peter F. Christoffersen
  • Lorenzo Giorgianni

When constructing hedged interest rate arbitrage portfolios for basket currencies, two issues arise: first, how are the unknown future basket weights optimally forecasted from past exchange rate data? And, second, how is risk—in terms of the conditional variance of expected profits from the interest rate arbitrage portfolio—appropriately measured when the basket weights are time-varying? Answers to these questions are provided within a time-varying parameter modeling framework estimated through the Kalman filter. An empirical application is devoted to the experience of the Thai baht currency basket (January 1992–February 1997).

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 99/16.

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Length: 30
Date of creation: 01 Jan 1999
Date of revision:
Handle: RePEc:imf:imfwpa:99/16
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