Arash, Aloosh (2011): Variance Risk Premium Differentials and Foreign Exchange Returns. Published in: EFA Doctoral Tutorial 2012 (18. August 2012)
Download (1MB) | Preview
The uncovered interest rate parity does not hold in the foreign exchange market (UIP puzzle). I use the cross-country variance risk premium differential to measure the excess foreign exchange return. Consequently, similar to Bansal and Shaliastovich (2010), I provide a risk-based explanation for the violation of UIP. The empirical results, based on the monthly data of ten currency pairs among US Dollar, UK Pound, Japanese Yen, Euro, and Swiss Franc, support the model both in-sample and out-of-sample.
|Item Type:||MPRA Paper|
|Original Title:||Variance Risk Premium Differentials and Foreign Exchange Returns|
|Keywords:||Consumption growth volatility-of-volatility; Variance risk premium differential; Global variance risk premium; Excess foreign exchange return; UIP|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets
F - International Economics > F3 - International Finance > F31 - Foreign Exchange
|Depositing User:||Arash Aloosh|
|Date Deposited:||24. Aug 2012 11:21|
|Last Modified:||12. Feb 2013 20:10|
Andrews, D. W. K. Heteroskedasticity and autocorrelation consistent covariance matrix estimation. Econometrica 59, 3 (May 1991), 817-58.
Backus, D., Foresi, S., and Telmer, C. Affine term structure models and the forward premium anomaly. The Journal of Finance 56, 1 (2001), 279-304.
Baele, L., Bekaert, G., and Inghelbrecht, K. The determinants of stock and bond return comovements. Review of Financial Studies 23, 6 (2010), 2374-2428.
Bali, T. G., and Zhou, H. Risk, uncertainty, and expected returns. Finance and Economics Discussion Series 2011-45, Board of Governors of the Federal Reserve System (U.S.), 2011.
Bansal, R., Khatchatrian, V., and Yaron, A. Interpretable asset markets? European Economic Review 49, 3 (2005), 531- 560.
Bansal, R., and Shaliastovich, I. A long-run risks explanation of predictability puzzles in bond and currency markets. Manuscript, Fuqua School of Business, Duke University (2010).
Bansal, R., and Yaron, A. Risks for the long run: A potential resolution of asset pricing puzzles. Journal of Finance 59, 4 (08 2004), 1481-1509.
Beeler, J., and Campbell, J. Y. The long-run risks model and aggregate asset prices: An empirical assessment. NBER Working Papers 14788, National Bureau of Economic Research, Inc, Mar. 2009.
Bekaert, G. The time variation of risk and return in foreign exchange markets: A general equilibrium perspective. Review of Financial Studies 9, 2 (1996), 427-70.
Bekaert, G., and Hodrick, R. J. Characterizing predictable components in excess returns on equity and foreign exchange markets. The Journal of Finance 47, 2 (1992), pp. 467-509.
Bollerslev, T., Marrone, J., Xu, L., and Zhou, H. Stock return predictability and variance risk premia: Statistical inference and international evidence. SSRN eLibrary (2011).
Bollerslev, T., Tauchen, G., and Zhou, H. Expected stock returns and variance risk premia. Review of Financial Studies 22, 11 (2009), 4463-4492.
Britten-Jones, M., and Neuberger, A. Option prices, implied price processes, and stochastic volatility. Journal of Finance 55, 2 (04 2000), 839-866.
Campbell, J., and Shiller, R. The dividend-price ratio and expectations of future dividends and discount factors. Review of nancial studies 1, 3 (1988), 195-228.
Cappiello, L., and De Santis, R. A. Explaining exchange rate dynamics: The uncovered equity return parity condition. SSRN eLibrary (2005).
Carr, P., and Wu, L. Variance risk premiums. Review of Financial Studies 22, 3 (2009), 1311-1341.
Cochrane, J. H. Asset Pricing. Princeton University Press, 2005.
Cochrane, J. H. Presidential address: Discount rates. Journal of Finance 66, 4 (08 2011), 1047-1108.
Colacito, R., and Croce, M. M. Risks for the long run and the real exchange rate. Journal of Political Economy 119, 1 (2011), 153-181.
Constantinides, G. M., and Ghosh, A. Asset pricing tests with long-run risks in consumption growth. Review of Asset Pricing Studies 1, 1 (2011), 96-136.
Del Negro, M. Aggregate risk sharing across us states and across european countries. Working paper, Yale University, January 1998.
Del Negro, M. Asymmetric shocks among u.s. states. Journal of International Economics 56, 2 (March 2002), 273-297.
Drechsler, I., and Yaron, A. What's vol got to do with it. Review of Financial Studies 24, 1 (2011), 1-45.
Engel, C. The forward discount anomaly and the risk premium: A survey of recent evidence. Journal of Empirical Finance 3, 2 (June 1996), 123-192.
Fama, E. The information in the term structure. Journal of nancial economics 13, 4 (1984), 509-528.
Hasseltoft, H. Stocks, bonds, and long-run consumption risks. Journal of Financial & Quantitative Analysis 47, 2 (2012), 309-332.
Hau, H., and Rey, H. Exchange rates, equity prices, and capital flows. Review of Financial Studies 19, 1 (Spring 2006), 273-317.
Hess, G. D., and Shin, K. Intranational business cycles in the united states. Journal of International Economics 44, 2 (April 1998), 289-313.
Hess, G. D., and Shin, K. Understanding the backus-smith puzzle: It's the (nominal) exchange rate, stupid. Journal of International Money and Finance 29, 1 (February 2010), 169-180.
Jiang, G. J., and Tian, Y. S. The model-free implied volatility and its information content. Review of Financial Studies 18, 4 (Winter 2005), 1305-1342.
Kandel, S., and Stambaugh, R. F. Expectations and volatility of consumption and asset returns. Review of Financial Studies 3, 2 (1990), 207-32.
Lauterbach, B. Consumption volatility, production volatility, spot-rate volatility, and the returns on treasury bills and bonds. Journal of Financial Economics 24, 1 (September 1989), 155-179.
Lustig, H., and Nieuwerburgh, S. V. How much does household collateral constrain regional risk sharing? Review of Economic Dynamics 13, 2 (April 2010), 265-294.
Lustig, H., Roussanov, N., and Verdelhan, A. Countercyclical currency risk premia. Working Paper 16427, National Bureau of Economic Research, September 2010.
Lustig, H., Roussanov, N., and Verdelhan, A. Common risk factors in currency markets. Review of Financial Studies 24, 11 (2011), 3731-3777.
Lustig, H., and Verdelhan, A. The cross section of foreign currency risk premia and consumption growth risk. American Economic Review 97, 1 (2007), 89-117.
Meese, R. A., and Rogoff, K. Empirical exchange rate models of the seventies: Do they t out of sample? Journal of International Economics 14, 1-2 (February 1983), 3-24.
Menkhoff, L., Sarno, L., Schmeling, M., and Schrimpf, A. Carry trades and global foreign exchange volatility. Journal of Finance 67, 2 (04 2012), 681-718.
Mueller, P., Vedolin, A., and Zhou, H. Short-run bond risk premia. SSRN eLibrary (2011).
Newey, W. K., and West, K. D. A simple, positive semi-denite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica 55, 3 (May 1987), 703-08.
Nicolin, P. Variance risk premiums in currency options.
Ostergaard, C., Serensen, B. E., and Yosha, O. Consumption and aggregate constraints: Evidence from u.s. states and canadian provinces. Journal of Political Economy 110, 3 (June 2002), 634-645.
Rogoff, K. Exchange rates in the modern floating era: what do we really know? Review of World Economics (Weltwirtschaftliches Archiv) 145, 1 (April 2009), 1-12.
Rogoff, K. S., and Stavrakeva, V. The continuing puzzle of short horizon exchange rate forecasting. NBERWorking Papers 14071, National Bureau of Economic Research, Inc, June 2008.
Santa-Clara, P., and Yan, S. Crashes, volatility, and the equity premium: Lessons from s&p 500 options. The Review of Economics and Statistics 92, 2 (07 2010), 435-451.
Stock, J. H., and Watson, M. W. Has the business cycle changed and why? NBER Macroeconomics Annual 17 (2002), pp. 159-218.
Stock, J. H., and Watson, M. W. Has the business cycle changed and why? In NBER Macroeconomics Annual 2002, Volume 17, NBER Chapters. National Bureau of Economic Research, Inc, 2003, pp. 159-230.
Todorov, V. Variance risk-premium dynamics: The role of jumps. Review of Financial Studies 23, 1 (2010), 345-383.
Verdelhan, A. A habit-based explanation of the exchange rate risk premium. Journal of Finance 65, 1 (2010), 123-146.
Verdelhan, A. The share of systematic variation in bilateral exchange rates. SSRN eLibrary (2012).
Welch, I., and Goyal, A. A comprehensive look at the empirical performance of equity premium prediction. Review of Financial Studies 21, 4 (July 2008), 1455-1508.
Wilcox, D. W. Social security benefits, consumption expenditure, and the life cycle hypothesis. Journal of Political Economy 97, 2 (April 1989), 288-304.
Zhou, H. Variance risk premia, asset predictability puzzles, and macroeconomic uncertainty. Federal Reserve Board, Working Paper (2009).