Was it risk? Or was it fundamentals? Explaining excess currency returns with kernel smoothed regressions

Richard T. Baillie and Kun Ho Kim

Journal of Empirical Finance, 2015, vol. 34, issue C, 99-111

Abstract: This paper uses recently developed kernel smoothing regression procedures and uniform confidence bounds to investigate the forward premium anomaly. These new statistical methods estimate the local time-varying slope coefficient of the regression of spot returns on the lagged interest rate differential. Uniform confidence bands are used to test when uncovered interest parity is violated. The estimated betas in the forward premium smoothed regression are found to vary substantially over time and to be partially explicable in terms of lagged fundamentals and money growth volatilities arising from risk premium. Frequentist model averaging procedures indicate the relative importance of these variables in terms of explaining movements in the betas and hence the apparent causes of regimes where UIP fails.

Keywords: Forward premium anomaly; Local Deviation from Uncovered Interest Parity; Kernel smoothing; Uniform inference; Macroeconomic fundamentals; Frequentist model averaging (search for similar items in EconPapers)
JEL-codes: C12 C14 C22 F31 F41 G15 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:34:y:2015:i:c:p:99-111

DOI: 10.1016/j.jempfin.2015.08.007

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Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

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