EMS exchange rate expectations and time-varying risk premia

In this paper we examine exchange risk premia employing a survey dataset of EMS exchange rates. We are able to test a risk premium model directly, i.e. without having to rely on the rational expectations assumption. Our results indicate that time-varying risk premia are present in almost all cases and that a GARCH-in-mean specification for the premium is often appropriate.     

Risk premia in forward foreign exchange rates: a comparison of signal extraction and regression methods

We investigate possible presence of time-varying risk premia in forward pound, yen, and Euro monthly exchange rates versus the US dollar over the last two decades. We study this issue using regression techniques and separately using a signal plus noise model. Our models account for time-varying volatility and non-normality in the observed series. Our regression model rejects the hypothesis that the forward rate is an unbiased predictor of future spot exchange rate, indicating the existence of time-varying risk premium under rational expectations. Our signal plus noise model reveals a time-varying risk premium component in yen and Euro. The same model provides evidence for the presence of risk premium in pound over a shorter sample period, though not over the entire sample. We conclude that risk premia exist, although we may fail to detect these for some currencies over specific time periods.     

The expectations theory of the term structure: Evidence from inflation forecasts

This paper tests the joint hypothesis of rational expectations and the expectations theory of the term structure using the Livingston survey data on price inflation forecasts. For a variety of sample periods, the paper presents evidence that the data are consistent with the theory. Since inflation forecasts, unlike interest rates, are not linked to specific underlying financial assets, the relationship between longterm and short-term inflation forecasts should not embody risk premia. This paper's findings therefore lend support to the view that a time-varying risk premium is needed to explain the observed term structure of interest rates.     

中国利率期限结构中的宏观经济风险因素分析——基于宏观-金融模型的研究途径

本文应用宏观-金融模型对我国利率期限结构动态过程中的时变宏观经济风险价格进行定量估计,在此基础上,对利率期限结构的预期成分和风险溢价成分进行分解,并且模拟了宏观经济对利率期限结构的冲击效应。研究结果表明,我国利率期限结构中存在着显著的时变宏观经济风险价格;不同期限利率可以明显地分解出预期成分和风险溢价成分,风险溢价成分的变动具有阶段性特点;宏观经济冲击在短期内对利率期限结构的整体水平与坡度均有明显影响,在长期内则仅对整体水平的影响较为明显。因此,我国利率期限结构可以体现出宏观经济形势的变化,应该进一步提高利率期限结构在货币政策制定中的作用。     

Interest expectations and exchange rates news

Using a new survey data set ofmatched exchange rate and interest rate expectations for eight currencies relative to the German mark, we examine empirically the relationship between exchange rate returns, news and risk premia. News on interest differentials enters significantly in equations for the difference between the spot rate and the lagged forward rate for the British pound, Japanese yen, Spanish peseta and the US dollar. An unexpected rise in the interest rate differential tends to strengthen the domestic exchange rate. For each of these currencies, we also find significant effects of our ex-ante measure of the risk premium. In addition, we investigate the effect of lagged interest rate differentials as proxy for the risk premium and find that they do not capture time-varying risk premia as is widely suggested in the literature, but probably capture a peso-problem, learning about a policy change, a market-inefficiency or a combination of these factors.     

A joint test of risk premia in exchange rates and rational expectations

This note presents a simple joint test of existence of a risk premium in exchange rates and the rationality of expectations. It is shown that major currency prices studied in this note are subject to a risk premium.     

Equity risk premium and time horizon: What do the U.S. secular data say?

We consider a representative investor whose wealth is made up of the equity market portfolio and the riskless asset, and who maximizes the expected utility of his/her future wealth for a given horizon. The solution of this program shows that the equilibrium value of the equity risk premium – the latter being measured by the difference between the expected equity portfolio return and the risk-free interest rate – is given by the product of the price of risk by the expected variance of stock returns. When returns are predictable, these two magnitudes are both time-varying and horizon-dependent. In accordance with this theoretical framework, our paper presents an econometric model of the equity risk premia for two traditional horizons: the one-period-ahead horizon (i.e. the ‘short-term’ premium) and the infinite-time horizon (i.e. the ‘long-term’ premium). Using annual US secular data from 1871 to 2008, and representing the expected returns by mixing the three traditional adaptive, extrapolative and regressive processes, large disparities in the dynamics of the two premia are evidenced. Concerning the determination of the equilibrium values of the two premia, the expected variances depend on the past values of the centered squared returns while the prices of risk (unobservable variables) are estimated according to the Kalman filter methodology, which enables us to capture the influence of hidden variables and of non-directly measurable psychological effects. A spread of interest rates adds to this determination. Possibly due to risky arbitrage and transaction costs, the results show that observed premia gradually converge towards their equilibrium values, this process being described by an error correction model. Overall, our model provides a rather satisfactory representation of ‘short-term’ and ‘long-term’ premia.     

Estimates of foreign exchange risk premia: a pricing kernel approach

The goal of this study is to measure market prices of risk and foreign exchange risk premia. Estimations of minimum variance pricing kernels permit to determine market prices of risk, which, in an international no-arbitrage framework, allow to measure foreign exchange risk premia. Market prices of risk are time-varying and surge during financial turmoils. Foreign exchange risk premia are on average small in comparison to interest rate differentials and exhibit significant variation from the early 1970s onwards, when the Bretton Woods exchange rate system collapsed. At times, foreign exchange risk premia dominate interest rate differentials. We are indebted to Baldev Raj, Robert Kunst, the associate editor of Empirical Economics and two anonymous referees for their valuable comments. We also thank seminar participants at the European Central Bank, the Bank of England and Queen Mary University of London. The views expressed in this paper are those of the authors and do not necessarily reflect those of the European Central Bank or the Eurosystem.     

Rethinking Deviations From Uncovered Interest Parity: the Role of Covariance Risk and Noise

We examine the ability of the standard intertemporal asset pricing model and a model of noise trading to explain why the forward foreign exchange premium predicts the future currency depreciation with the 'wrong' sign. We find that the intertemporal asset pricing model is unable to predict risk premia with the correct sign to be consistent with the data. The noise-trader model, while highly stylised, receives fragmentary support from empirical research on survey expectations.     

Foreign currency debt, risk premia and macroeconomic volatility

This paper studies the relationships between foreign currency debt, macroeconomic volatility, and risk premia in a model of a small open emerging market economy. The external value of the local currency is counter-cyclical, so that foreign currency debt requires larger repayments than local currency debt in bad states of nature. The level of foreign currency-denominated debts, therefore, affects the volatility of aggregate demand and by extension of the exchange rate. Exchange rate volatility is in turn an important determinant of the risk premium on local currency debt. Finally, this risk premium is a major factor in the choice of local versus foreign currency for emerging market borrowers. The mutual endogeneity of foreign currency debt, risk premia, and macroeconomic volatility creates important feedback effects in the economy: small increases in international risk aversion may entail large amplification effects on macroeconomic volatility since domestic borrowers substitute towards cheaper but riskier foreign currency debt finance.     

Bond risk premia, macroeconomic fundamentals and the exchange rate

We propose a two-country no-arbitrage term-structure model to analyze the joint dynamics of bond yields, macroeconomic variables and the exchange rate. The model allows to understand how exogenous shocks to the exchange rate affect the yield curves, how bond yields co-move in different countries and how the exchange rate is influenced by interest rates, macro-economic variables and time-varying bond risk premia.Estimating the model with US and German data, we find that time-varying bond risk premia account for a significant portion of the variability of the exchange rate: apparently, a currency tends to appreciate when investors expect large capital gains on long-term bonds denominated in that currency. A number of other novel empirical findings emerge.     

Bond risk premia,macroeconomic fundamentals and the exchange rate

We propose a two-country no-arbitrage term-structure model to analyze the joint dynamics of bond yields, macroeconomic variables and the exchange rate. The model allows to understand how exogenous shocks to the exchange rate affect the yield curves, how bond yields co-move in different countries and how the exchange rate is influenced by interest rates, macro-economic variables and time-varying bond risk premia.Estimating the model with US and German data, we find that time-varying bond risk premia account for a significant portion of the variability of the exchange rate: apparently, a currency tends to appreciate when investors expect large capital gains on long-term bonds denominated in that currency. A number of other novel empirical findings emerge.     

Tests of real interest parity in international currency markets

The purpose of this paper is to examine the behavior of real bilateral exchange rates for major currencies and test the hypothesis of real uncovered interest parity with risk premia, and forward looking expectations. It is plausible that the hypothesis of rational expectations cannot be rejected given the unit root nonstationarity of real exchange rates but it is not unlikely that unit root nonstationarity may be due to rational expectations in foreign exchange markets.     

Using survey data to test market efficiency in the foreign exchange markets

The paper uses cointegration methods to test the market efficiency hypothesis (MEH) in the foreign exchange markets. Four exchange rates are considered-all relative to the US dollar: BP, DM, SF and JY. Survey data on expectations are used to see whether the violation of the MEH is due to expectational errors or risk premia. The results differ for the one-week ahead and the one-month ahead forecasts. With the weekly data we conclude that it is risk premia, and with the monthly data it is both expectational errors and risk premia that account for the violation of the MEH. Given the volatility of the exchange markets, it appears that forecasts over an extended period fail tests of rationality, but one-week ahead forecasts do not fail such tests.     

Diverse beliefs and time variability of risk premia

Why do risk premia vary over time? We examine this problem theoretically and empirically by studying the effect of market belief on risk premia. Individual belief is taken as a fundamental primitive state variable. Market belief is observable; it is central to the empirical evaluation and we show how to measure it. Our asset pricing model is familiar from the noisy REE literature but we adapt it to an economy with diverse beliefs. We derive equilibrium asset prices and implied risk premium. Our approach permits a closed form solution of prices; hence we trace the exact effect of market belief on the time variability of asset prices and risk premia. We test empirically the theoretical conclusions. Our main result is that, above the effect of business cycles on risk premia, fluctuations in market belief have significant independent effect on the time variability of risk premia. We study the premia on long positions in Federal Funds Futures, 3- and 6-month Treasury Bills (T-Bills). The annual mean risk premium on holding such assets for 1?C12?months is about 40?C60 basis points and we find that, on average, the component of market belief in the risk premium exceeds 50% of the mean. Since time variability of market belief is large, this component frequently exceeds 50% of the mean premium. This component is larger the shorter is the holding period of an asset and it dominates the premium for very short holding returns of less than 2?months. As to the structure of the premium we show that when the market holds abnormally favorable belief about the future payoff of an asset the market views the long position as less risky hence the risk premium on that asset declines. More generally, periods of market optimism (i.e. ??bull?? markets) are shown to be periods when the market risk premium is low while in periods of pessimism (i.e. ??bear?? markets) the market??s risk premium is high. Fluctuations in risk premia are thus inversely related to the degree of market optimism about future prospects of asset payoffs. This effect is strong and economically very significant.     

Nonlinear adjustment in the forward premium: evidence from a threshold unit root test

This paper considers testing the mean reversion of the forward premium in a nonlinear framework. In contrast to previous studies, we consider a novel approach that allows for testing for a unit root in the forward premium while explicitly allowing for nonlinearity in the data. Within this approach, we employ bootstrap methods based on threshold autoregressive (TAR) models to investigate whether the 1- and 3-month forward premia for six industrialized countries are mean-reverting. Overall, we are able to reject the null hypotheses of linearity and nonstationarity indicating nonlinear mean reversion. Furthermore, large deviations of the forward premium from its equilibrium band are found to have faster speed of mean reversion than small deviations, which are strongly persistent. In all, the results support the view that the forward premium exhibits mean reversion, but in a special manner not captured by the usual linear tests. Finally, the results have important implications for foreign exchange market efficiency under risk aversion.     

Austrian exporters: unique or alike? New insights and missing puzzle pieces

In this paper we provide detailed evidence on the performance of exporters compared to non-exporters in Austrian manufacturing industries based on firm-level data. The centrepiece of the study is the issue of the export premium, i.e. the size and productivity advantages of exporting firms compared to their purely domestic peers. We present evidence for the existence of sales, labour productivity and wage premia. These results are largely in line with the results found for other European countries. Furthermore we document the existence of large differences in these premia across industries and provide explanations for this finding. Our results are robust with regards to including additional firm control variables such as employment and R&D-related variables though the magnitudes of the export premia become much smaller. We also propose a new interpretation of the export premium estimation with firm fixed effects which we interpret as a result on export switchers. Finally, we employ a probit model to document the importance of sunk export costs for the decision to export.     

Eco-labeling in commercial office markets: Do LEED and Energy Star offices obtain multiple premiums?

This paper investigates the effect of eco-labeling on rental rates, sale prices and occupancy rates. The consensus emerging from previous studies appears to be that investors in and occupiers of eco-labeled buildings obtain a bundle of benefits related to lower operating costs, reputation benefits and productivity higher. In this study, a hedonic model is used to test whether the presence of an eco-label has a significantly positive effect on rental rates, sale prices and occupancy rates of commercial office buildings in the US. The results suggest that office buildings with Energy Star or LEED eco-labels obtain rental premia of approximately 3-5%. Dual certification produces an additive effect with rental premia estimated at 9%. Respective sale price premia for Energy Star and LEED labeled office buildings are 18% and 25%. The sale price premium for dual certification is estimated at 28-29%. An occupancy premium could not be confirmed for LEED labeled office buildings and only a small positive occupancy premium was found for Energy Star.     

Efficiency in the Forward Foreign Exchange Market: Weekly Tests of the Australian/US Dollar Exchange Rate January 1984-March 1987*

This paper examines the relationship which exists between the spot and forward Australian/US Dollar exchange rates for one-, three-and six-month contracts using weekly data over the period January 1984—March 1987. The paper splits the forward premium into a component due to risk and one which is due to a forecasting error, and this analysis is suggestive of a time-varying risk premium.     

Inflation and real short-term interest rates - A Kalman filter analysis of the term structure

This paper applies the Kalman filter technique to look at the relationship among real interest rates, inflation, and the term structure of interest rate under the expectations hypothesis. Using quarterly data from 1960:1 to 1991:1 for inflation, three month nominal short term interest rates and long term yields with maturities from one to five years, this paper finds that the expectations hypothesis of the term structure holds up well for the data under the assumptions of a time-varying premium and a random-walk real interest rate. In other words, a reconciliation of the expectations hypothesis with the data is attained by assuming time-varying term premium and non-stationary real interest rate.