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Subjective Currency Risk Premia and Deviations from Moving Averages

Author

Listed:
  • Steve Furnagiev
  • Josh Stillwagon

    (Department of Economics, Trinity College)

Abstract

This paper examines the empirical performance of an alternative model of the currency risk premium. The model predicts that the premium on foreign exchange will depend positively on the gap between the exchange rate and its benchmark value. In this paper, we relate the benchmark not to relative prices but to a moving average process in accord with technical analysis. The model is tested against a novel data set of traders' exchange rate forecasts, from 1986:08 to 2013:09, to measure the subjective, ex ante premium. This eliminates the need for a joint hypothesis of rational expectations and enables more direct focus on risk behavior. Using the Cointegrated VAR (CVAR), strong support is found for this hypothesis, as the exchange rate's deviation from a one-year moving average is significant at the 1% level and forms a stationary cointegrating relationship with the premium for the four USD exchange rates examined (against the Swiss franc, Japanese yen, British pound, and Canadian dollar).

Suggested Citation

  • Steve Furnagiev & Josh Stillwagon, 2015. "Subjective Currency Risk Premia and Deviations from Moving Averages," Working Papers 1506, Trinity College, Department of Economics.
    • Handle: RePEc:tri:wpaper:1506
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    File URL: http://www3.trincoll.edu/repec/WorkingPapers2015/WP15-06.pdf
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    More about this item

    Keywords

    Exchange rates; risk premia; survey data; IKE gap model; moving average; CVAR;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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    This paper has been announced in the following NEP Reports:

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