Estimating a Latent Risk Premium in Exchange Rate Futures

46 Pages Posted: 25 May 2018

See all articles by Kerstin Bernoth

Kerstin Bernoth

German Institute for Economic Research (DIW Berlin)

Jürgen von Hagen

University of Bonn

Casper G. de Vries

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Tinbergen Institute; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: May 2018

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

JEL Classification: F31, F37, G13

Suggested Citation

Bernoth, Kerstin and Hagen, Jürgen von and De Vries, Casper, Estimating a Latent Risk Premium in Exchange Rate Futures (May 2018). DIW Berlin Discussion Paper No. 1733. Available at SSRN: https://ssrn.com/abstract=3180598 or http://dx.doi.org/10.2139/ssrn.3180598

Kerstin Bernoth (Contact Author)

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Jürgen von Hagen

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

Casper De Vries

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands
+31 10 408 8956 (Phone)
+31 10 408 9147 (Fax)

Tinbergen Institute

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands
+31 10 408 8956 (Phone)
+31 10 408 9147 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

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