Intervention and the Risk Premium in Foreign Exchange Rates (original) (raw)
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Intervention and the foreign exchange risk premium: An empirical investigation of daily effects
1990
Currency markets have witnessed a sharp increase in government intervention since 1985. Many observers believe that this intervention promoted the dollar's depreciation between 1985 and early 1987, and that intervention has since helped to stabilize dollar exchange rates. This paper tests for a systematic effect of daily dollar intervention on exchange rate risk premia. We test for both portfolio balance effects and signaling influences by using daily data on central bank intervention (in dollars) against both the yen and the West German mark. Following work by Dominguez (1989) and Loopesko (1984), we measure the daily risk premium in terms of the deviation from uncovered interest parity. However, we follow other empirical analyses of exchange rates and allow for generalized conditional autoregressive heteroscedasticity (GARCH). Some evidence is found for both the portfolio balance and signaling channels.
Since the Plaza Meeting in September 1985, G-10 central banks have intervened in foreign exchange markets in a manner and scale unprecedented in the post Bretton Woods era. Using official daily data on interventions by the Swiss National Bank, this paper evaluates the effectiveness of these interventions and examines their impact on exchange rate risk premia, as defined by deviations from interest rate parity. My results suggests that intervention (via its effect on the risk premium) may be responsible for the frequently observed failure of foreign exchange market efficiency models and for their poor out-ofsample forecasting performance
Since the Plaza Meeting in September 1985, G-10 central banks have intervened in foreign exchange markets in a manner and scale unprecedented in the post Bretton Woods era. Using official daily data on interventions by the Swiss National Bank, this paper evaluates the effectiveness of these interventions and examines their impact on exchange rate risk premia, as defined by deviations from interest rate parity. My results suggests that intervention (via its effect on the risk premium) may be responsible for the frequently observed failure of foreign exchange market efficiency models and for their poor out-ofsample forecasting performance
Determinants of Currency Risk Premiums
SSRN Electronic Journal, 2000
This paper presents a theoretical model of exchange-rate determination intended to address the forward premium puzzle. It also explains the empirical observation that risk premiums depend on interest differentials. The model's closed-form solution indicates that currency risk premiums depend on two factors: interest differentials and the current deviation of the exchange rate from its long-run equilibrium. If speculators have an alternative to exchange-rate speculation, then there is no presumption that uncovered interest parity holds even approximately in long-run equilibrium. The model is consistent with existing evidence suggesting that forward premiums are negatively related to rationally expected future exchange rate changes. New empirical evidence is provided in support of the model.
On biases in the measurement of foreign exchange risk premiums
Journal of International Money and Finance, 1993
The hypothesis that the forward rate is an unbiased predictor of the future spot rate has been consistently rejected in recent empirical studies. This paper examines several sources of measurement error and misspecification that might induce biases in such studies. Although previous inferences are shown to be robust to a failure to construct true returns and to omitted variable bias arising from conditional heteroskedasticity in spot rates, we show that the parameters were not stable over the 1975-89 sample period. Estimation that allows for endogenous regime shifts in the parameters demonstrates that deviations from unbiasedness were more severe in the 1980s. (JEL F31). This paper reexamines the relation of the forward premium in the foreign exchange market to the expected rate of currency depreciation over the life of the forward contract. For at least ten years, empirical studies of this relation have regressed ex post rates of depreciation on a constant and the forward premium. Their null hypothesis is that the slope coefficient is one. Researchers have consistently found point estimates of the slope coefficient that are negative and that are often more than two standard errors from zero. Predicted currency depreciation is therefore very different from the forward premium whereas the unbiasedness hypothesis implies that they are equal.
Factors Affecting the Exchange Rate Risk Premium
Journal of Applied Finance and Banking, 2016
The objective of this work is to identify and examine the risk premium of the exchange rate; then, to determine the factors that cause it, and to measure its variance by using a GARCH-M model. Some theoretical models are developed by taking the exchange rate risk premium as dependent variable and other macrovariables, political events, and market conditions as independent ones. There are three different exchange rates
Macroeconomic and policy uncertainty and exchange rate risk premium
2004
The goal of this paper is to identify the main determinants of the risk premium in some European currency markets just before the EMU. To that extent, we start from Lucas (1982) exchange rate model and derive an analytical expression for the forward premium. This expression includes money and production variables and it is quite standard, except for the inclusion of macroeconomic policy risk. Under some standard assumptions, this formula simplifies substantially and becomes amenable to regression analysis. Then, using standard measures of money and production, as well as interest rate swap spreads as indicators of macroeconomic policy risk, the theoretical expression is estimated. We provide evidence suggesting that it is policy uncertainty, much more than fundamental macroeconomic uncertainty, which determined risk premium over the convergence process to the euro. Whether these results can be extended to similar experiences for other currency unions remains open for future research. JEL Classification: F31, F41, G12, G15
Currency risk premiums: Theory and Evidence
2003
Economists have long been perplexed by the negative relationship between short-run exchange-rate changes and interest differentials, known as the "forward premium puzzle." This paper develops an exchange-rate model that accounts for all of the notable empirical regularities associated with this puzzle. The model focuses on short-run exchange-rate dynamics, consistent with the short-run focus of the puzzle. This short-run focus, together with recent evidence on currency market microstructure, explains why the model incorporates a central role for flow demand and supply. In modeling speculative agents we note that, because of agency problems, short-term traders are encouraged to focus on profits rather than consumption. The model's clear analytic solutions show that risk premiums can be time varying and strongly negatively related to interest differentials. Simulations show that the volatility of exchange-rate returns exceeds the volatility of both interest differentials and forward premiums, and that exchange-rate persistence is quite low while that of expected excess returns is fairly high. Regression estimates using quarterly data for five currencies pr ovide strong support for the model, suggesting that currency microstructure may have macroeconomic relevance.
Recently, only econometric models like GARCH and EGARCH investigated the instant effects of central banks interventions. Humpage (2000) investigates the intervention policy of the Federal Reserve Bank of the USA in the period 23 September-31 December, 1985 by using a nonparametric test suggested by Merton (Journal of Business, 1981). In this paper, I rely on a new strategy implied by the intervention modeling that outperforms the used non-parametric test one. This methodology is considered a very important tool; it leads to evaluating the instant and dynamic effects in long term and for avoiding future economic shocks. As far as my knowledge, this is the first study investigating the effects of foreign exchange market interventions on the exchange rate by using the intervention modeling. Keywords: Central bank intervention, dynamic effects, time series outliers, intervention modeling.