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

Published online by Cambridge University Press:  30 October 2017

Josh R. Stillwagon
Josh R. Stillwagon*
Affiliation:
Babson College and Institute for New Economic Thinking (INET) Program on Imperfect Knowledge Economics (IKE)
*
Address correspondence to: Josh R. Stillwagon, Economics Division, Westgate Hall, Babson College, 231 Forest Street, Babson Park, MA 02457, USA; email: jstillwagon@babson.edu.
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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.

Keywords

Risk PremiumSurvey DataI(2) CVARReal Exchange Rate
Type
Articles
Information
Macroeconomic Dynamics , Volume 22 , Issue 2 , March 2018 , pp. 255 - 278
Copyright
Copyright © Cambridge University Press 2017 

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Footnotes

I would like to thank Michael D. Goldberg, Mostafa Beshkar, Bruce Elmslie, Roman Frydman, Søren Johansen, Katarina Juselius, Anders Rahbek, Peter Sullivan, and Le Wang for many helpful comments on earlier versions of this work. I would also like to thank an associate editor and two anonymous referees for invaluable suggestions, which greatly improved the paper.

References

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