New Evidence on the Portfolio Balance Approach to Currency Returns

40 Pages Posted: 5 Mar 2019

See all articles by Nevin Cavusoglu

Nevin Cavusoglu

James Madison University

Michael D. Goldberg

University of New Hampshire

Joshua Stillwagon

Trinity College (Hartford CT)

Date Written: January 2019

Abstract

This paper re-examines the empirical performance of the portfolio balance approach to currency returns. It considers the implications of two alternative specifications of preferences: one based on expected utility theory and the other on prospect theory. It also uses survey data to estimate models of ex-ante rather than ex-post returns. The empirical analysis relies on the co-integrated VAR framework, which is well suited for testing competing models and dealing with unit roots. Like earlier studies, we find little support for the expected utility theory model. By contrast, the prospect theory model’s predictions are largely borne out in the data, including those about sign reversals. We find the strongest support for a hybrid model that incorporates the risk factors of both portfolio balance specifications.

Keywords: International CAPM, Prospect Theory, Risk Premium, Co-integrated VAR, Survey Expectations

JEL Classification: F31, D81, D84, G10

Suggested Citation

Cavusoglu, Nevin and Goldberg, Michael D. and Stillwagon, Joshua, New Evidence on the Portfolio Balance Approach to Currency Returns (January 2019). Institute for New Economic Thinking Working Paper Series No. 89 (2019). Available at SSRN: https://ssrn.com/abstract=3346757 or http://dx.doi.org/10.2139/ssrn.3346757

Nevin Cavusoglu

James Madison University

No Address Available

Michael D. Goldberg

University of New Hampshire ( email )

Durham, NH 03824
United States
603-862-3385 (Phone)
603-862-3383 (Fax)

HOME PAGE: http://pubpages.unh.edu/~michaelg/

Joshua Stillwagon (Contact Author)

Trinity College (Hartford CT) ( email )

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