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A DYMIMIC Model of Forward Foreign Exchange Risk, with Estimates for Three Major Exchange Rates

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  • Taylor, Mark P

Abstract

One explanation which has been proposed for the failure of the forward exchange rate to act as an unbiased predictor of the future spot rate is the exist ence of a time-varying risk premium. This paper models the risk premi um as a latent variable depending upon domestic and foreign asset yie ld volatility, using an unobservable components framework. Estimates of the model for dollar-sterling, dollar-Swiss franc and dollar-Japan ese yen, obtained by maximum likelihood Kalman filtering techniques, are encouraging. Copyright 1988 by Blackwell Publishers Ltd and The Victoria University of Manchester

Suggested Citation

  • Taylor, Mark P, 1988. "A DYMIMIC Model of Forward Foreign Exchange Risk, with Estimates for Three Major Exchange Rates," The Manchester School of Economic & Social Studies, University of Manchester, vol. 56(1), pages 55-68, March.
    • Handle: RePEc:bla:manch2:v:56:y:1988:i:1:p:55-68
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    Cited by:

    1. Roberts, Mark A., 1995. "Imperfect information: Some implications for modelling the exchange rate," Journal of International Economics, Elsevier, vol. 38(3-4), pages 375-383, May.
    2. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    3. Guneratne Banda Wickremasinghe, 2004. "Efficiency Of Foreign Exchange Markets: A Developing Country Perspective," International Finance 0406004, University Library of Munich, Germany.
    4. Luca Benati, 2006. "Affine term structure models for the foreign exchange risk premium," Bank of England working papers 291, Bank of England.
    5. Benamar, Abdelhak & CHERIF, Nasreddine & Benbouziane, Mohamed, 2011. "Money and prices in the Maghreb countries: cointegration and causality analyses," MPRA Paper 38604, University Library of Munich, Germany.
    6. Morley, Bruce & Pentecost, Eric J., 1998. "Asset pricing and foreign exchange risk: econometric evidence for the G-7," Journal of International Money and Finance, Elsevier, vol. 17(2), pages 317-329, April.
    7. Guneratne B Wickremasinghe & Jae H Kim, 2008. "Weak-Form Efficiency of Foreign Exchange Markets of Developing Economies," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 7(2), pages 169-196, August.
    8. Benbouziane, Mohamed & Benamar, Abdelhak, 2004. "The relationship between money and prices in the maghreb countries: a cointegration analysis," MPRA Paper 12741, University Library of Munich, Germany.
    9. Barabás, Gyula, 1996. "Kamatparitás lebegő és csúszó leértékeléses árfolyamrendszerben [Interest parity in floating and in crawling-peg foreign exchange rate régimes]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(11), pages 972-994.
    10. Koning, Camiel de & Straetmans, Stefan, 1998. "Time varying forex market inefficiency," Serie Research Memoranda 0063, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
    11. Canale, Rosaria Rita, 2002. "Equilibrium exchange rate theories under flexible exchange rate regimes," MPRA Paper 3086, University Library of Munich, Germany.
    12. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    13. Shively, Philip A., 2000. "Stationary time-varying risk premia in forward foreign exchange rates," Journal of International Money and Finance, Elsevier, vol. 19(2), pages 273-288, April.

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