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Estimating a Latent Risk Premium in Exchange Rate Futures

Kerstin Bernoth (), Jürgen von Hagen and Casper de Vries ()

No 1733, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

Abstract: Using exchange rates futures instead of forwards completes the maturity spectrum of the correlation between the spot return and the premium. The correlation decreases with increasing maturity, presumably due to a latent risk premium. We hypothesize that the influence of the unobserved risk factor has a contract-specific risk component. Our main contribution is to control for the omitted variable bias by using a modified version of the CCE panel estimator in combination with futures data. This renders the coefficient on the futures premium insignificantly different from one. Subsequently, the contract-specific part is related to conventional proxies of risk.

Keywords: Forward premium puzzle; CCE estimation; futures rates; latent risk (search for similar items in EconPapers)
JEL-codes: F31 F37 G13 (search for similar items in EconPapers)
Pages: 43 p.
Date: 2018
New Economics Papers: this item is included in nep-opm
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