Subjective Currency Risk Premia and Deviations from Moving Averages

Steve Furnagiev and Josh Stillwagon ()

No 1506, Working Papers from Trinity College, Department of Economics

Abstract: This paper examines the empirical performance of an alternative model of the currency risk premium. The model predicts that the premium on foreign exchange will depend positively on the gap between the exchange rate and its benchmark value. In this paper, we relate the benchmark not to relative prices but to a moving average process in accord with technical analysis. The model is tested against a novel data set of traders' exchange rate forecasts, from 1986:08 to 2013:09, to measure the subjective, ex ante premium. This eliminates the need for a joint hypothesis of rational expectations and enables more direct focus on risk behavior. Using the Cointegrated VAR (CVAR), strong support is found for this hypothesis, as the exchange rate's deviation from a one-year moving average is significant at the 1% level and forms a stationary cointegrating relationship with the premium for the four USD exchange rates examined (against the Swiss franc, Japanese yen, British pound, and Canadian dollar).

Keywords: Exchange rates; risk premia; survey data; IKE gap model; moving average; CVAR (search for similar items in EconPapers)
JEL-codes: F31 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2015-07
New Economics Papers: this item is included in nep-mon and nep-opm
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http://www3.trincoll.edu/repec/WorkingPapers2015/WP15-06.pdf First version, 2015 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:tri:wpaper:1506

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