A Nonlinear Analysis of Forward Premium and Volatility
Chiente Hsu and Peter Kugler
Department of Economics
University of Bern
Pages 187-201
Abstract
In this paper we investigate the relationship between risk premium and
a time-varying conditional variance of spot rate using weekly Swiss
franc/US dollar exchange-rate data. First, we apply an EGARCH-in-mean
framework to test the unbiasedness hypothesis of the forward rate with
a volatility dependent risk premium. The corresponding estimates point
to no significant influence of volatility on the risk premium, and
reject the unbiasedness hypothesis. Second, we apply a
seminonparametric, nonlinear impulse-response analysis to the
spot-rate change and the forward premium. This framework allows us to
analyze the risk premium/volatility relationship without using a
specific, parametric model such as EGARCH-in-mean. The latter analysis
confirms the negative EGARCH-in-mean results with respect to the risk
premium/volatility relationship, although the volatility dynamics
estimated is clearly different from that implied by the EGARCH
estimate. Moreover, the forward premium has a nonlinear dynamic
influence on the spot rate, whereas the converse is not true.
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