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ARE RISK PREMIA RELATED TO REAL EXCHANGE RATE SWINGS? EVIDENCE FROM I(2) CVARs WITH SURVEY EXPECTATIONS

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  • Stillwagon, Josh R.

Abstract

This paper finds strong evidence of a positive relationship between currency risk premia and real exchange rate swings, significant at the 1% if not 0.1% level, for three US$ exchange rate samples. The risk premia are measured using survey data on traders' exchange rate forecasts. This circumvents the need for an auxiliary hypothesis of rationality and enables more direct focus on risk behavior. The analysis is conducted using the I(2) cointegrated VAR, which allows for time-varying trends in the variables. Evidence of persistent changes is found for interest rates, prices, and nominal and real exchange rates. Interest rate shocks appear to drive the system, whereas expectations are correcting only in the longer run.

Suggested Citation

  • Stillwagon, Josh R., 2018. "ARE RISK PREMIA RELATED TO REAL EXCHANGE RATE SWINGS? EVIDENCE FROM I(2) CVARs WITH SURVEY EXPECTATIONS," Macroeconomic Dynamics, Cambridge University Press, vol. 22(2), pages 255-278, March.
    • Handle: RePEc:cup:macdyn:v:22:y:2018:i:02:p:255-278_00
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    Cited by:

    1. Takamitsu Kurita & Patrick James, 2022. "The Canadian–US dollar exchange rate over the four decades of the post‐Bretton Woods float: An econometric study allowing for structural breaks," Metroeconomica, Wiley Blackwell, vol. 73(3), pages 856-883, July.
    2. Cavusoglu, Nevin & Goldberg, Michael D. & Stillwagon, Josh, 2021. "Currency returns and downside risk: Debt, volatility, and the gap from benchmark values," Journal of Macroeconomics, Elsevier, vol. 68(C).
    3. Josh Stillwagon & Peter Sullivan, 2020. "Markov switching in exchange rate models: will more regimes help?," Empirical Economics, Springer, vol. 59(1), pages 413-436, July.
    4. Yuanyuan Li & Dietmar Bauer, 2020. "Modeling I(2) Processes Using Vector Autoregressions Where the Lag Length Increases with the Sample Size," Econometrics, MDPI, vol. 8(3), pages 1-28, September.
    5. Nevin Cavusoglu & Michael D. Goldberg & Joshua Stillwagon, 2019. "New Evidence on the Portfolio Balance Approach to Currency Returns," Working Papers Series 89, Institute for New Economic Thinking.

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