the pricing of currency risk in japan abstract previous work on the pricing of exchange rate risk has primarily focused on us firms and surprisingly found stock returns were not significantly affected by exchange rate fluctuations in this paper we conduct an in depth investigation that examines whether exchange rate risk is priced in the equity market of japan using an intertemporal asset pricing testing procedure that allows risk premia to change through time in response to changes in macroeconomic conditions our multiperiod asset pricing tests show that the foreign exchange rate risk premium is a significant component of japanese stock returns specifically the results suggest that currency risk exposure commands a significant risk premium for multinationals and high exporting japanese firms the currency risk factor is found to be less influential in explaining the behavior of average returns for low exporting and domestic firms however it is shown to exhibit large return volatility that is likely to be perceived by investors who wish to control portfolio risk as an important underlying source of risk furthermore japanese stock returns are found to be related to the relative distress and size factors above and beyond the covariation explained by the currency risk factor

lessons from strange cases democracy development and the resource curse in the u s states the work linking natural resource wealth to authoritarianism and under development suffers from several shortcomings in this article the authors outline those shortcomings and address them in a new empirical setting using a new data set for the u s states spanning 73 years and case studies of texas and louisiana the authors are able to more carefully examine both the diachronic nature and comparative legs of the resource curse hypothesis than previous research has they provide evidence that natural resource dependence contributes to slower economic growth poorer developmental performance and less competitive politics using this empirical setting they also begin parsing the mechanisms that might explain the negative association between resource wealth and political and economic development they draw implications from intranational findings for resource abundant countries across the world and suggest directions for future cross national and cross state work

estimation and simulation of risk premia in equity and foreign exchange markets abstract there is substantial evidence to reject constant risk premia financial models while time varying risk premia are often mentioned as an alternative the literature has yet to produce an example that accounts for the important time series properties of asset returns we inquire whether mean variance optimization models can do so we model asset risk with an absolute error version of the arch in mean hypothesis and model hedging motives that derive from variation in future real income and inflation to account for agent heterogeneity we consider a three country and two asset world our model predicts values for five excess returns relative to the us bill rate we use a systems approach to estimate the model parameters and then simulate the estimated model to determine if it can account for the important time series properties of risk premia

on universal currency hedges this paper identifies five universal currency hedge ratio uhr definitions these are hedge positions in foreign bonds stated as a fraction of national or global equity portfolios that are the same for all investors regardless of nationality the first three involve the total demand for foreign bonds and depend on equities not being held for hedging purposes the last two are associated with variance minimizing regression hedges these hold in general but are designed exclusively for hedging other traded asset positions jensen s inequality makes the choice of measurement currency irrelevant and makes the hrs universal without affecting their values

tests of conditional asset pricing with time varying moments and risk prices this paper tests conditional capital asset pricing models in a multivariate garch framework employing both constant and time varying prices of market and bond risk depending on the interpretation of the market portfolio the icapm with one hedge portfolio or the two factor myopic capm are supported using weekly data from july 1983 to december 1989 in contrast we reject the myopic single factor capm under a constant price of market risk we find that interest rate risk is highly significant which suggests that previous rejections of the conditional capm using only stock market data may be due to omitted hedge terms or an incomplete market factor

international asset pricing and portfolio diversification with time varying risk we test the conditional capital asset pricing model capm for the world s eight largest equity markets using a parsimonious generalized autoregressive conditional heteroskedasticity garch parameterization our methodology can be applied simultaneously to many assets and at the same time accommodate general dynamics of the conditional moments the evidence supports most of the pricing restrictions of the model but some of the variation in risk adjusted excess returns remains predictable during periods of high interest rates our estimates indicate that although severe market declines are contagious the expected gains from international diversification for a u s investor average 2 11 percent per year and have not significantly declined over the last two decades

crossing the lines the conditional relation between exchange rate exposure and stock returns in emerging and developed markets this paper examines the importance of exchange rate exposure in the return generating process for a large sample of non financial firms from 37 countries we argue that the effect of exchange rate exposure on stock returns is conditional and show evidence of a significant return impact to firm level currency exposures when conditioning on the exchange rate change we further show that the realized return to exposure is directly related to the size and sign of the exchange rate change suggesting fluctuations in exchange rates as a source of time variation in currency return premia for the entire sample the return impact ranges from 1 2 to 3 3 per unit of currency exposure and it is larger for firms in emerging markets compared to developed markets overall the results indicate that foreign exchange rate exposure estimates are economically meaningful despite the fact that individual time series results are noisy and many exposures are not statistically significant and that exchange rate exposure plays an important role in generating cross sectional return variation moreover we show that the relation between exchange rate exposure and stock returns is more consistent with a cash flow effect than a discount rate effect

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

financial statement comparability and expected crash risk this study examines the impact of financial statement comparability on ex ante crash risk using the comparability measures of de franco et al 2011 we find that expected crash risk decreases with financial statement comparability and this negative relation is more pronounced in an environment where managers are more prone to withhold bad news we also provide evidence that comparability can mitigate the asymmetric market reaction to bad versus good news disclosures our results suggest that financial statement comparability disinclines managers from bad news hoarding which reduces investors perceptions of a firm s future crash risk

the statistical properties of daily foreign exchange rates 1974 1983 abstract this paper examines the statistical properties of daily rates of change of five foreign currencies from 1974 to 1983 the main purpose is to discriminate between two competing explanations for the observed heavy tails of the distribution that the data are independently drawn from a heavy tail distribution which remains fixed over time and that the data come from distributions which vary over time evidence point to the rejection of the first hypothesis further investigations show that the rejection can be attributed to changing means and variances in the data which can be described by a simple statistical model

diffusion and the international context of democratization democracy does not evolve sui generis the spatial clustering in democ racy and transitions suggests that international factors play a prominent role in forg ing democracies as well as influencing their durability we argue that democracy often comes about as a result of changes in the relative power of important actors and groups as well as their evaluations of particular institutions both of which are often influenced by forces outside the country in question the scope and extent of con nections with other democratic countries in a region can strengthen support for dem ocratic reform and help sustain institutions in transitional democracies results from a transition model demonstrate that international factors can exert a strong influence on the prospects for transitions to democracy and the spatial clustering in democ racy and transitions cannot adequately be explained by the hypothesized domestic social requisites of individual countries

in search of the exchange risk premium a six currency test assuming mean variance optimization abstract a number of authors examining deviations of actual rates of currency depreciation from forward discounts have claimed to find evidence of risk premiums if these deviations are indeed partly due to risk premiums rather than being entirely due to expectational errors then they should be systematically related to those variables on which risk premiums are thought to depend finance theory tells us that if investors optimize with respect to mean and variance the risk premium depends in a specific way on 1 the supplies of assets denominated in the various currencies 2 the variance covariance matrix of the rates of return and 3 the coefficient of risk aversion the null hypothesis of this paper is that the coefficient of risk aversion is zero countries assets are perfect substitutes and risk premiums are nonexistent the alternative hypothesis is that rates of return are systematically related to asset supplies by a macroeconomic portfolio balance function the maximum likelihood technique used dominates previous attempts to find such a relationship in that the parameters of the portfolio balance function are constrained to depend on the variance covariance matrix as the finance theory says they should on the other hand the technique also dominates previous applications of the finance theory in that the expected returns are allowed to vary over time as the macroeconomic portfolio balance theory says they should the paper s finding is a statistical inability to reject the null hypothesis for a portfolio of six currencies although this could be due to low power in the test

analysing the risk premium in the italian stock market arch m models versus non parametric models this paper investigates the variability of the risk premium in the italian stock market over the period 1978 89 we have modelled voatility using two different approaches arch m models and non parametric models the estimate of the arch m models confirm the existence of both an arch process in the variance and a time varying risk premium also the non parametric specification confirms the existence of a time varying risk premium moreover in both models the acceleration in the inflation rate has a negative effect on stock prices

the implications of mean variance optimization for four questions in international macroeconomics abstract the hypothesis of mean variance optimization has powerful implications transcending particular methods used for variance covariance estimation 1 for conventional estimates of risk aversion substitutability between domestic and foreign securities is close to perfect in the sense that risk premiums are small in magnitude a few basic points and thus cannot explain much bias in forward rates 2 nevertheless as long as risk aversion is not zero foreign exchange intervention still affects the level of the exchange rate proportionately at least to asset supply changes 3 current account deficits also have effects 4 finally dollar depreciation should not be accompanied by appreciation of the mark against the franc

a note on exchange rate expectations and nominal interest differentials a test of the fisher hypothesis this note tests the hypothesis that nominal interest differentials between similar assets denominated in different currencies can be explained entirely by the expected change in the exchange rate over the holding period this proposition often called the fisher open hypothesis or the hypothesis of perfect asset substitutability has been a major component of recent theories of exchange rate determination and has important implications for monetary policy 1 the fisher hypothesis differs from the covered interest parity theorem enunciated by keynes 11 while covered interest parity equates the nominal interest differential between financial centers to a known premium or discount on forward foreign exchange and is thus in principle riskless fisher parity involves risk in an essential way the two conditions are equivalent only when forward exchange rates equal expected future spot rates recent theoretical work for example that of grauer litzenberger and stehle 8 kouri 12 and frankel 6 shows that this need not be the case when market participants are risk averse thus while covered interest parity must always hold exactly in an informationally efficient asset market with no transactions costs fisher parity need not nominal interest differentials may reflect risk premia in addition to expected exchange rate movements 2 it should be emphasized at the outset that the tests conducted in this paper are really joint tests of the fisher hypothesis and a weak form of foreign exchange market informational efficiency levich 14 has argued that tests of market efficiency are always joint tests involving some hypothesized structure of normal equilibrium returns below we assume informational efficiency and instead test fisher s hypothesized arbitrage condition that nominal interest differentials equal expected percentage changes in exchange rates

accelerated gaussian importance sampler with application to dynamic latent variable models summary we propose a new generic and highly efficient accelerated gaussian importance sampler agis for the numerical evaluation of very high dimensional density functions a specific case of interest to us is the evaluation of likelihood functions for a broad class of dynamic latent variable models the feasibility of our method is strikingly illustrated by means of an application to a first order dynamic stochastic volatility model for daily stock returns whose likelihood for an actual sample of size 2022 is evaluated with high numerical accuracy by means of 10 000 monte carlo replications the estimated model parsimoniously dominates arch and garch alternatives one of which includes twelve lags

time varying risk premia volatility and technical trading rule profits evidence from foreign currency futures markets abstract this paper re examines the efficiency of foreign currency futures markets by evaluating the role of time varying risk premia and volatility in explaining technical trading rule profits the results show that large parts of the technical rule profits can be explained by the time varying risk premia estimated from a general model for the conditional capm the bootstrap distributions for the profits under the null model average one third to one half of the actual profits and enclose the actual profits well within the 90 confidence intervals time varying conditional volatility explains an additional 10 of the profits

the stochastic volatility in mean model empirical evidence from international stock markets in this paper we present an exact maximum likelihood treatment for the estimation of a stochastic volatility in mean svm model based on monte carlo simulation methods the svm model incorporates the unobserved volatility as an explanatory variable in the mean equation the same extension is developed elsewhere for autoregressive conditional heteroscedastic arch models known as the arch in mean arch m model the estimation of arch models is relatively easy compared with that of the stochastic volatility sv model however efficient monte carlo simulation methods for sv models have been developed to overcome some of these problems the details of modifications required for estimating the volatility in mean effect are presented in this paper together with a monte carlo study to investigate the finite sample properties of the svm estimators taking these developments of estimation methods into account we regard sv and svm models as practical alternatives to their arch counterparts and therefore it is of interest to study and compare the two classes of volatility models we present an empirical study of the intertemporal relationship between stock index returns and their volatility for the united kingdom the united states and japan this phenomenon has been discussed in the financial economic literature but has proved hard to find empirically we provide evidence of a negative but weak relationship between returns and contemporaneous volatility which is indirect evidence of a positive relation between the expected components of the return and the volatility process copyright 2002 john wiley sons ltd

a dynamic globally diversified index neutral synthetic asset allocation strategy an investor with the ability to assess the prospective return and risk structure of the global capital markets can construct portfolios that over time will not only outperform actively or passively managed domestic asset portfolios but will also outperform passively managed global portfolios a bayesian approach to dynamic seemingly unrelated regression dsur is a robust and effective means to forecast the one step ahead conditional distribution of asset returns this approach recognizes the time varying nature of the global capital markets the predictive moments are used to derive a single factor return model once an index portfolio is specified the index portfolio represents an investor s underlying portfolio given the factor model that assesses the relative attractiveness and risk of the assets in relation to the index an index neutral portfolio is constructed as an overlay to enhance the returns of the index portfolio this portfolio is mean variance optimal is notional neutral i e the sum of the asset exposures is zero and has returns that are designed to be uncorrelated with the returns of the index portfolio the implementation of such an index neutral portfolio using derivative securities is simulated over the period january 1988 to december 1993

pre holiday effects international evidence on the decline and reversal of a stock market anomaly abstract the pre holiday effect is one of the best known of the calendar effect anomalies this paper extends prior work by examining whether the effect has declined for the u s u k and hong kong markets for all three markets the effect is shown to have declined but only significantly in the u s the result is not surprising given the relative sophistication of the market what is surprising however is the reversal of the pre holiday effect during the period 1991 1997 with the mean return on pre holiday days becoming negative and the subsequent elimination of this effect during 1997 2003

the joint response of stock and foreign exchange markets to macroeconomic surprises using us and japanese data abstract this paper investigates the joint response of stock and foreign exchange fx market returns to macroeconomic surprises employing a system method of estimation that allows for the cross country and cross market interaction for asset returns and risk premia using us and japanese data we find that us stock markets are asymmetrically responsive to domestic developments in output growth and interest rates but are not influenced by macroeconomic surprises from japan the surprise in the fx market seems to affect stock markets in the us and japan respectively in particular we find that the interest rate surprise in the us and inflation surprise in japan tend to overstate the impact that these surprises would have on the respective stock market the impact of the surprises would appear smaller if macroeconomic developments induced by the fx market were incorporated into the model

can cross country portfolio rebalancing give rise to forward bias in fx markets abstract this paper develops a model of exchange rate dynamics that takes into account positions in foreign and domestic equities in addition to standard short term riskless securities the modeling of cross country stock holdings is motivated by evidence that a large and ever increasing proportion of currency flows has been directed toward national stock markets to the extent that there is not perfect risk sharing investors tend to hold currency risk and international equity risk as a bundle this paper examines the impact of such cross country covariance risk on the relationship between exchange rate returns and interest rate differentials in particular we show that the sign and magnitude of the coefficient on the lagged interest differential is governed by a type of time varying beta risk that reflects the conditional covariance between exchange rate returns and the return differential between foreign and domestic equities as this cross country beta is predominantly negative our results have direct implications on the empirical failure of the uncovered interest parity uip hypothesis suggesting that the traditional uip regression equation is confounded in a non standard nonlinear way by the presence of cross country equity flows simulation experiments show that accounting for such portfolio rebalancing activities may in part help to explain the anomalous slope coefficient associated with the forward premium

interest rate differentials and exchange rate policies in austria the netherlands and belgium in this paper the small but persistent interest rate differentials via a vis germany which have existed in austria the netherlands and belgium are analysed these interest differentials may be thought of to consist of three parts expected exchange rate movements within the band expected changes of the central rates and a risk premium following a similar test as proposed by svensson we examine the credibility of the exchange rate policy in these countries according to this test the belgian exchange rate policy clearly lacks credibility for most of the period under consideration there are however serious problems applying this test to belgium due to the dual exchange rate system for austria and the netherlands we calculate interest differentials which are adjusted for expected exchange rate movements within the band it appears that the differences between the adjusted and the unadjusted interest differentials can be substantial the granger causal relationship between fundamentals like the rate of inflation the government budget deficit and the current account is also quite different for the adjusted and the unadjusted interest differential where the fundamentals have the highest explanatory power for the latter measure

the time variation of risk and return in the foreign exchange and stock markets this paper attempts to determine whether the fluctuations of conditional first and second moments which are observed for many assets are consistent with the sharpelintner mossin capital asset pricing model we test the mean variance model under several different assumptions about the time variation of conditional second moments of returns using weekly data from july 1974 to december 1986 that include returns on a portfolio composed of dollar deutsche mark sterling and swiss franc assets together with the u s stock market the results indicate that estimated conditional variances cannot explain the observed time variation of risk premia rates of return on international financial assets are characterized by statistical properties that are quite common to all financial markets they are highly volatile and largely unpredictable these properties make it very difficult to extract statistically reliable estimates of systematic exchange rate and assetprice movements and are at the root of the generally poor empirical performance of international asset pricing models nevertheless two important results have been uncovered by empirical researchers and can be considered a fair characterization of the data a expected returns on foreign assets vary over time cumby and obstfeld 1981 and the numerous articles that followed recently surveyed by frankel and meese 1987 b the volatility of returns of foreign assets also changes over time cumby and obstfeld 1984 hodrick and srivastava 1984 and hsieh 1988 among others as giovannini and jorion 1987 suggest the

time varying betas and risk premia in the pricing of forward foreign exchange contracts abstract this paper specifies the single beta capital asset pricing model for the pricing of forward foreign exchange contracts from the point of view of a u s investor parametric specification of the betas as arch like processes explicitly allows for time variation as well as sign variation of the risk premium in the forward foreign exchange market i estimate the model jointly for four currencies using a generalized method of moments procedure the results show significant time variation for the betas and tests of the overidentifying restrictions are generally favorable to the model

can bank be a source of contagion during the 1997 asian crisis abstract this paper tests whether bank can be a source of contagion during the 1997 asian crisis using asset return data from a crisis country thailand in particular i examine whether thai banking sector can produce contagion effects in both conditional means and volatilities of its foreign exchange and stock markets during the crisis after controlling economic fundamentals the test results show that contagion in mean effects appear to be multidirectional since return shocks emanating from any one of the three markets can sweep across all markets but contagion in volatility effects are mainly driven by the negative return shocks originating in the banking sector overall the empirical evidence indicates that the past return shocks emanating from banking sector have significant impact not only on the volatilities of foreign exchange and aggregate stock markets but also on their prices suggesting that bank can be a major source of contagion during the crisis

time varying risk aversion an application to energy hedging abstract risk aversion is a key element of utility maximizing hedge strategies however it has typically been assigned an arbitrary value in the literature this paper instead applies a garch in mean garch m model to estimate a time varying measure of risk aversion that is based on the observed risk preferences of energy hedging market participants the resulting estimates are applied to derive explicit risk aversion based optimal hedge strategies for both short and long hedgers out of sample results are also presented based on a unique approach that allows us to forecast risk aversion thereby estimating hedge strategies that address the potential future needs of energy hedgers we find that the risk aversion based hedges differ significantly from simpler ols hedges when implemented in sample risk aversion hedges for short hedgers outperform the ols hedge ratio in a utility based comparison

tests of international capm with time varying covariances we perform maximum likelihood estimation of a model of international asset pricing based on capm we test the restrictions imposed by capm against a more general asset pricing model the betas in our capm vary over time as the supplies of assets change and as the conditional covariances or returns on those assets change we let the covariances change over time as a function of macroeconomic data and an alternative model allows the covariances to follow a multivariate arch process we also can identify a modified capm model with measurement error we find that the estimated capm performs much better when variances are not constant over time nonetheless capm is rejected in favour of the lessrestricted model of asset pricing

do natural resources fuel authoritarianism a reappraisal of the resource curse a large body of scholarship finds a negative relationship between natural resources and democracy extant cross country regressions however assume random effects and are run on panel datasets with relatively short time dimensions because natural resource reliance is not an exogenous variable this is not an effective strategy for uncovering causal relationships numerous sources of bias may be driving the results the most serious of which is omitted variable bias induced by unobserved country specific and time invariant heterogeneity to address these problems we develop unique historical datasets employ time series centric techniques and operationalize explicitly specified counterfactuals we test to see if there is a long run relationship between resource reliance and regime type within countries over time both on a country by country basis and across several different panels we find that increases in resource reliance are not associated with authoritarianism in fact in many specifications we generate results that suggest a resource blessing

the covariation of risk premiums and expected future spot exchange rates abstract eugene fama 1984 analyzed the variability and the covariation of risk premiums and expected rates of depreciation we employ three statistical techniques that do not suffer from a potential bias in fama s analysis but we nevertheless conffirms his findings in contrast to his interpretation the results are not necessarily at variance with the predictions of a theoretical model of the risk premium increases in expected rates of depreciation of the dollar relative to five foreign currencies are positively correlated with increases in the expected profitability of purchasing these currencies in the forward market and risk premiums have larger variancies than expected rates of depreciation

an equilibrium model of exchange rate determination and asset pricing with nontraded goods and imperfect information this paper presents a two country model with maximizing households stochastic production stochastic money growth and perfect capital mobility because of the presence of nontraded goods households in different countries consume different goods analytic solutions are presented for the nominal exchange rate the real exchange rate nominal interest rates and real interest rates it is shown that the model is compatible with some important features of the real world behavior of exchange rates when households are imperfectly informed about the distribution of money growth the exchange rate exhibits patterns of overshooting and is more volatile than the ratio of the money stocks copyright 1987 by university of chicago press

dependence structure between the equity market and the foreign exchange market a copula approach abstract this paper investigates the dependence structure between the equity market and the foreign exchange market by using copulas in particular several copulas with different dependence structure are compared and used to directly model the underlying dependence structure we find that there exists significant symmetric upper and lower tail dependence between the two financial markets and the dependence remains significant but weaker after the launch of the euro our findings have important implications for both global investment risk management and international asset pricing by taking into account joint tail risk

estimation methods for stochastic volatility models a survey abstract although stochastic volatility sv models have an intuitive appeal their empirical application has been limited mainly due to difficulties involved in their estimation the main problem is that the likelihood function is hard to evaluate however recently several new estimation methods have been introduced and the literature on sv models has grown substantially in this article we review this literature we describe the main estimators of the parameters and the underlying volatilities focusing on their advantages and limitations both from the theoretical and empirical point of view we complete the survey with an application of the most important procedures to the s p 500 stock price index

foreign exchange risk premia volatility once again abstract in a recent paper in this journal we analyze the puzzle of excess volatility of risk premia in the foreign exchange market one of our conclusions was that allowing for the observed time variation of conditional variances the static mean variance model can predict movements in risk premia of the same order of magnitude as in the empirical data unfortunately the derivation in our paper contains an error which falsifies our claim this note presents a brief correction of our previous computations and an assessment of the corrected results

predicting volatility in the foreign exchange market measures of volatility implied in option prices are widely believed to be the best available volatility forecasts in this article we examine the information content and predictive power of implied standard deviations isds derived from chicago mercantile exchange options on foreign currency futures the article finds that statistical time series models even when given the advantage of ex post parameter estimates are outperformed by isds isds however also appear to be biased volatility forecasts using simulations to investigate the robustness of these results the article finds that measurement errors and statistical problems can substantially distort inferences even accounting for these however isds appear to be too variable relative to future volatility it is widely believed that the volatility implied in option prices is the market s best estimate of future volatility after all if it were not one could devise a trading strategy that could generate profits by identifying mispriced options the purpose of this article is to investigate the information content and predictive power of volatility implied in options on foreign currencies the paper focuses on options on currency futures traded on the chicago mercantile exchange cme because of the depth and liquidity of cme futures and options traded side by side in the same market implied standard deviations isds allow for clean tests of the predictive power of implied volatilities early studies of the information content of isds have generally found that these contain substantial information for future volatility latane and rendleman 1976 chiras and manaster 1978 and beckers 1981 for example regress future volatility on the weighted implied volatility across a broad sample of chicago board options exchange cboe stocks and find that options contain volatility forecasts that are more accurate than historical measures 1 these studies performed shortly after the 1973 beginning of the cboe option market could only use a relatively short time span and therefore focused on cross sections rather than time series predictions

dynamic portfolio adjustment and capital controls a euler equation approach we present a multiasset dynamic portfolio balance model that is based on the maximization of an intertemporal utility function in consumption when investors operate under uncertainty quadratic adjustment costs and capital market regulations we estimate the model s structural parameters on quarterly portfolio data of the german private sector asset demand is insensitive to return changes although the coefficients are significant adjustment costs are low but highly significant giving rise to moderate lags of adjustment still existing capital controls and adjustment costs cannot explain the currently observed home bias in the portfolio overall our results imply a strong rejection of the portfolio model

a new approach to international arbitrage pricing this paper uses a nonlinear arbitrage pricing model a conditional linear model and an unconditional linear model to price international equities bonds and forward currency contracts unlike linear models the nonlinear arbitrage pricing model requires no restrictions on the payoff space allowing it to price payoffs of options forward contracts and other derivative securities only the nonlinear arbitragepricing model does an adequate job of explaining the time series behavior of a cross section of international returns the idea that a few relevant state variables explain expected returns is the main driving force of the seminal papers of merton 1973 and ross 1976 these seminal ideas have been extended to the pricing of international assets by ikeda 1991 ross and walsh 1983 solnik 1974 1983 and stulz 1981 among others the key implication of these arbitrage pricing models is that only risks related to these factors state variables are relevant in determining asset prices testable implications of these international asset pricing models have been derived either by placing restrictions on the payoff structure i e payoffs are linear in factors as in ikeda 1991 ross and walsh 1983 and solnik 1983 or on the joint distributions of the payoffs and state variables as in constantinides 1989 these restrictions lead to the testable implication that expected asset returns are linear in the conditional covariances with the factor payoffs in what follows we refer to these models as linear arbitrage models or linear models

anomalies foreign exchange most all behavior can be explained by assuming that agents have stable well defined preferences and make rational choices consistent with those preferences in markets that eventually clear an empirical result qualifies as an anomaly if it is difficult to rationalize or if implausible assumptions are necessary to explain it within the paradigm this column will present a series of such anomalies readers are invited to suggest topics for future columns by sending a note with some reference to or better yet copies of the relevant research comments on anomalies printed here are also welcome the address

a maximum likelihood approach for non gaussian stochastic volatility models a maximum likelihood approach for the analysis of stochastic volatility models is developed the method uses a recursive numerical integration procedure that directly calculates the marginal likelihood only conventional integration techniques are used making this approach both flexible and simple experimentation shows that the method matches the performance of the best estimation tools currently in use new stochastic volatility models are introduced and estimated the model that best fits recent stock index data is characterized by a highly non gaussian stochastic volatility innovation distribution this model dominates a model that includes an autoregressive conditional heteroscedastic effect in the stochastic volatility process and a model that includes a stochastic volatility effect in the conditional mean

interest rate parity and foreign exchange risk premia in the erm abstract in this paper we evaluate uncovered interest rate parity in the erm by testing market efficiency and zero risk premia in a general asset pricing framework the overidentifying conditions derived from the model are not rejected but we strongly reject risk neutrality nevertheless estimated risk premia between erm currencies are moderate to low therefore due to the diversifiability of foreign exchange risk the standard uip relation between exchange rates and interest rates is a reasonable approximation within the erm

tests of asset pricing with time varying expected risk premiums and market betas tests of asset pricing models are developed that allow expected risk premiums and market betas to vary over time these tests exploit the relation between expected excess returns and current market values using weekly data for 1963 through 1982 on ten common stock portfolios formed according to equity capitalization a single risk premium model is not rejected if the expected premium is time varying and is not constrained to correspond to a market factor conditional mean variance efficiency of a value weighted stock index is rejected and the rejection is insensitive to how much variability of expected risk premiums is assumed financial economists have studied valuation models in which securities expected returns are related to the covariances of unanticipated returns with the return on the market portfolio or with other risk factors empirical tests of such models typically have employed unconditional sample moments of returns recent studies provide mounting evidence that expected returns change over time with information such evidence presents an opportunity to develop new approaches for evaluating and implementing asset pricing models that exploit this time variation this paper presents new tests of financial valuation models in which expected returns are allowed to vary over time time series of relative

currency hedging for international portfolios this paper examines the benefits from currency hedging both for speculative and risk minimization motives in international bond and equity portfolios the riskreturn performances of globally diversified portfolios are compared with and without forward contracts over the period 1974 to 1990 inclusion of forward contracts results in statistically significant improvements in the performance of unconditional portfolios containing bonds conditional strategies are also implemented both in sample and out of sample and are shown to both significantly improve the risk return tradeoff of global portfolios and to outperform unconditional hedging strategies whether international portfolios should be hedged against currency risks is the subject of an active debate the theoretical side of the debate has been closely associated with two strands in the academic literature international asset pricing and optimal hedging in the futures markets in the international asset pricing model iapm of solnik 1974 optimal portfolios contain positions in forward contracts or equivalently foreign currency denominated bills these positions which can differ from the positions in foreign stocks have since been termed hedges black 1990 shows that under additional assumptions the hedge ratios should be identical for all investors regardless of their nationality universality and that investors should never fully hedge their foreign currency exposures similarly theoretical models from the futures literature produce demands for hedging instruments that contain both speculative and hedging components the empirical issue unanswered so far is whether adding forward contracts to international portfolios significantly improves the risk return profile of global investments empirical research has barely begun to respond to the challenges of theoretical models there exists little empirical evidence on either the relevance of black s universal hedge ratios or the optimality of hedge ratios less than one instead researchers have concentrated on the benefits of fully hedging exchange risk for example eun and resnick 1988 indicate that stock portfolios perform better when fully hedged but offer no statistical tests

the behavior of eurocurrency returns across different holding periods and monetary regimes recent empirical studies of the risk premium across foreign exchange and other asset markets such as equity and longer term bonds have found conflicting evidence about the latent variable model restrictions of the consumption based intertemporal capital asset pricing model while studies using data for holding periods of one month or less generally reject the model evidence using three month holding periods indicates that the model cannot be rejected when including the returns on long relative to short deposit rates this paper investigates the sources of differences in results using returns on foreign exchange and eurocurrency deposits at three different maturities

exchange rate risk premiums abstract a state space model which allows for the covariation of risk premiums and unexpected rates of depreciation is used to study exchange rate risk premiums we find that exchange rate risk premiums have a high degree of persistence and the covariance of risk premiums and unexpected rates of depreciation is negative regressions of the estimated risk premium on its determinants implied by the equilibrium model of lucas 1982 show limited support for the model jel f31

monetary policy liquidity and foreign exchange markets an exploration abstract this paper explores empirically the fluctuations of money demand arising from financial markets fluctuations in financial markets liquidity are reflected in interest rates and asset returns the paper uses daily data on the swiss franc and other currencies from january 1 1980 until december 31 1987 and is based on a priori knowledge on the timing of liquidity shocks in the empirical analysis i ask whether at the time liquidity shocks occur abnormal rates of return can be observed in the foreign exchange markets

an international capm for bonds and equities abstract previous empirical studies of international capm models have not found much supporting evidence in this paper we suggest reasons why this might have happened and perform new tests using improved models and data a range of monthly capm models are estimated for 1973 1987 for aggretate equities and bonds in germany japan the us and uk the models are an improvement on earlier work in that we integrate equity markets into the analysis instead of focusing exclusively on government bond stocks and we carefully measure the rates of return for both bonds and equities in particular bond returns reflect changes in the price of bonds as well as coupons despite this wider portfolio and the introduction of arch effects in the conditional covariance matrix of errors our model still yields unlikely estimates of the coefficient of relative risk aversion and provides very little explanatory power for expected relative rates of return correcting the icapm for these major deficiencies does not reverse earlier conclusions in the literature a close examination of the residuals of the estimated equations suggest that garch models are not required for our new data set jel fh

spread and volatility in spot and forward exchange rates abstract this paper is concerned with modeling the conditional heteroscedasticity of the prediction error of foreign exchange rates as spot and forward rates are cointegrated we use a system of error correction models for mean prediction to predict the variance we use a vibariate generalized autoregressive conditional heteroscedasticity garch model as a function of the spread using daily series for seven currencies we find that unmodeled conditional heteroscedasticity by garch can generally be explained by the squared spread this indicates that as the spread is bigger the exchange rates are more volatile jel f31 c32

the persistence of volatility and stock market fluctuations this paper examines the potential influence of changing volatility in stock market prices on the level of stock market prices it demonstrates that volatility is only weakly serially correlated implying that shocks to volatility do not persist these shocks can therefore have only a small impact on stockmarket prices since changes in volatility affect expected required rates of return for relatively short intervals these findings lead us to be skeptical of recent claims that the stock market s poor performance during the 1970 s can be explained by volatility induced increases in risk premia this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item

recent estimates of time variation in the conditional variance and in the exchange risk premium abstract the optimal diversification model of investors portfolio behavior can give a linear relationship between the exchange risk premium and the conditional exchange rate variance this note surveys recent empirical work that allows the conditional variance itself and therefore the risk premium to vary over time in particular it examines the implications of recent empirical estimates for earlier arguments based on the assumption that the conditional variance was constant over time that the exchange risk premium had to be small in magnitude and variability

does foreign exchange intervention matter the portfolio effect until recently there was an unusual degree of consensus among economists that intervention by central banks in the foreign exchange market did not offer an effective or lasting instrument for affecting the exchange rate at least not independently of monetary policy this consensus was largely shared among policymakers and participants in the financial markets as well the 1982 g 7 economic summit at versailles commissioned a study of intervention known as the jurgenson report which found that the effects were small and transitory at most we think that the time is ripe for new statistical testing of the question many policymakers and foreign exchange traders believe that the intervention operations that have taken place since the plaza agreement of september 1985 have had an effect especially when operations are coordinated moreover the theoretical case against the effectiveness of intervention is not as clear as a reading of the economics literature might suggest the academic literature is predicated on the distinction between intervention operations that are sterilized and those that are allowed to affect the money supply we study the intervention operations that actually took place between 1982 and 1988 regardless of whether they were sterilized however we do begin in section i with a review of the issues involved 2 there are two possible channels through which intervention whether sterilized or not can influence the foreign exchange rate the portfolio and the expectations channels intervention can even if sterilized influence exchange rates through the portfolio channel provided foreign and domestic bonds are considered imperfect substitutes in investors portfolios intervention operations that for example increase the current relative supply of mark to dollar assets which private investors are obliged to accept into their portfolios will force a decrease in the relative price of mark assets 3 intervention can also influence exchange rates regardless of whether foreign and domestic bonds are imperfect substitutes through the expectations channel the public information that central banks are intervening in support of a currency or are planning to intervene in the future may under certain conditions cause speculators to expect an increase in the price of that currency in the future speculators react to this information by buying the currency today bringing about the change in the exchange rate today in sections ii and iii we describe the econometric problems that arise in the standard portfolio balance estimation equation we derive an alternative portfolio balance dominguez kennedy school of government harvard university 79 j f kennedy street cambridge ma 02138 frankel department of economics university of california 787 evans hall berkeley ca 94720 we thank three anonymous referees for valuable comments and suggestions julia marsh and julia lowell for research assistance and franz scholl at the bundesbank jean pierre roth at the swiss national bank and officials at the u s treasury and the board of governors of the federal reserve system for making the daily intervention data available 1many of the econometric results finding little or no effect were reported in kenneth s rogoff 1984 and dale w henderson and stephanie sampson 1983 2for authoritative statements see henderson 1984 or maurice obstfeld 1990 3the exchange rate reaction to an increase in the relative supply of outside foreign assets may be reduced if there is an increase in their expected rate of return that induces a corresponding increase in demand

the time variation of expected returns and volatility in foreign exchange markets this article analyzes the time variation in conditional means and variances of monthly and quarterly excess dollar returns on eurocurrency investments all results are based on a vector autoregression with weekly sampled data on exchange rate changes and forward premiums of three currencies both past exchange rate changes and forward premiums predict future forward market returns moreover past forward premium volatilities predict the volatility of exchange rates expected forward market returns are very variable and persistent and exhibit marked comovements these results carry over to cross rate e g yen mark investments as well

fed intervention dollar appreciation and systematic risk abstract in a four factor asset pricing model estimated on daily data fed intervention significantly affects betas of surprises in the market return expected inflation rate yield curve and corporate bond risk premium fed foreign currency sales cause economically and statistically significant increases in the systematic risk premium in appreciation and thus in the dollar s expected appreciation rate the direction the fed desires and consistent with the signaling but not the portfolio balance channel intervention s effects on actual appreciation are less reliable they depend on unpredictable risk factor realizations even successful intervention to strengthen the dollar may be costly by increasing the dollar s systematic risk intervention reduces the attractiveness of u s relative to foreign investments further uncertainty about future fed interventions may induce resource misallocation ceteris paribus investors find it harder to estimate risk adjusted discount rates and forecast the home currency value of cash flows

optimal dynamic hedging portfolios and the currency composition of external debt abstract we present a model which shows that the currency composition of a country s external debt can serve as a hedging instrument against changes in exchange rates and commodity prices because our model permits the second moments to change through time we get a sequence of optimal dynamic hedging portfolios which can be estimated with a multivariate generalized autoregressive conditional heteroskedasticity garch model to illustrate the usefulness of the technique we apply it to indonesia and it is found as expected that indonesia s optimal debt portfolio consists of a much larger proportion of us dollars and a much smaller proportion of japanese yen than they have in their current debt portoflio

why do we reject the mean variance model a two stage test procedure for the static mean variance portfolio model is presented which focuses on increasingly restrictive versions of the general model it also delivers clues to the probable cause of rejection the procedure is applied to quarterly data for german private net wealth the mean variance restrictions are strongly rejected because the data reject any positive semi definite link between returns and asset holdings this suggests that the failure of the model is not primarily caused by neglect of the time variation of conditional covanances

maximum likelihood estimation of latent affine processes this article develops a direct filtration based maximum likelihood methodology for estimating the parameters and realizations of latent affine processes filtration is conducted in the transform space of characteristic functions with a version of bayes rule used for recursively updating the joint characteristic function of latent variables and the data conditional upon past data an application to daily stock returns over 1953 96 reveals substantial divergences from emm based estimates in particular more substantial and time varying jump risk the implications for stock index options prices are discussed

markov switching and stochastic volatility diffusion models of short term interest rates this article empirically compares the markov switching and stochastic volatility diffusion models of the short rate the evidence supports the markov switching diffusion model estimates of the elasticity of volatility parameter for single regime models unanimously indicate an explosive volatility process whereas the markov switching models estimates are reasonable itis found that either markov switching or stochastic volatility but not both is needed to adequately fit the data a robust conclusion is that volatility depends on the level of the short rate finally the markov switching model is the best for forecasting a technical contribution of this article is a presentation of quasi maximum likelihood estimation techniques for the markov switching stochastic volatility model

a utility based approach to energy hedging abstract a key issue in the estimation of energy hedges is the hedgers attitude towards risk which is encapsulated in the form of the hedgers utility function however the literature typically uses only one form of utility function such as the quadratic when estimating hedges this paper addresses this issue by estimating and applying energy market based risk aversion to commonly applied utility functions including log exponential and quadratic and we incorporate these in our hedging frameworks we find significant differences in the optimal hedge strategies based on the utility function chosen

premia in forward foreign exchange as unobserved components a note we reconsider the signal extraction approach to measuring premia in the pricing of forward foreign exchange put forward by wolff in which the difference between the forward rate and the associated future spot rate is modeled as an autoregressive moving average arma model for the risk premium buried in a white noise forecast error we point out that an arma model for the risk premium is not always identifiable from information on the difference between the forward rate and the future spot rate only we present solutions to the problem of identification and show how the model for the risk premium can be estimated in a direct way provided that the identification problem is solved for reason of comparison we use the series analyzed by wolff to estimate the models for risk premia the results confirm the earlier finding that premia in forward exchange exhibit a certain degree of persistence over time

the price variability volume relationship on speculative markets this paper concerns the relationship between the variability of the daily price change and the daily volume of trading on the speculative markets our work extends the theory of speculative markets in two ways first we derive from economic theory the joint probability distribution of the price change and the trading volume over any interval of time within the trading day and second we determine how this joint distribution changes as more traders enter or exit from the market the model s parameters are estimated by fiml using daily data from the 90 day t bills futures market the results of the estimation can reconcile a conflict between the price variability volume relationship for this market and the relationship obtained by previous investigators for other speculative markets this paper concerns the relationship between the variability of the daily price change and the volume of trading on speculative markets previous empirical studies 2 3 6 12 14 16 of both futures and equity markets always find a positive association between price variability as measured by the squared price change ap2 and the trading volume 2 there are two explanations for the relationship clark s 2 explanation which is secondary to his effort to explain why the probability distribution of the daily price change is leptokurtic emphasizes randomness in the number of within day transactions in clark s model the daily price change is the sum of a random number of within day price changes the variance of the daily price change is thus a random variable with a mean proportional to the mean number of daily transactions clark argues that the trading volume is related positively to the number of within day transactions and so the trading volume is related positively to the variability of the price change the second explanation is due to epps and epps 6 their model examines the mechanics of within day trading the change in the market price on each within day transaction or market clearing is the average of the changes in all of the traders reservation prices epps and epps assume there is a positive relationship between the extent to which traders disagree when they revise their reservation prices and the absolute value of the change in the market price that is an increase in the extent to which traders disagree is associated with a larger absolute price change the price variability volume relationship arises then because the volume of trading is positively related to the extent to which traders disagree when they revise their reservation prices

is it signalling exchange intervention and the dollar deutschemark rate abstract the portfolio balance channel for sterilised intervention is tested by examining the effects of changes in relative asset supplies on the dollar deutschemark rate during the 1980s in contrast to previous studies we control for any signalling effects of central bank intervention and find a weak but statistically significant portfolio balance influence on the exchange rate

why empirical international portfolio models fail evidence that model misspecification creates home asset bias abstract international portfolio models consistently predict that investors should put much more of their wealth into foreign assets than they actually do a result known as home asset bias we use actual international portfolio data to show how model misspecification contributes to this bias we find that three widely used simplifying assumptions produce optimal portfolio weights that are significantly different from the weights produced by an unsimplified model in particular imposing the invalid assumption that ppp holds exaggerates the degree of home asset bias these findings suggest that researchers should pay greater attention to empirical model specification in the future