Affine Models of Currency Pricing

42 Pages Posted: 28 Apr 1998 Last revised: 9 Apr 2010

See all articles by David K. Backus

David K. Backus

NYU Stern School of Business; National Bureau of Economic Research (NBER)

Silverio Foresi

Goldman Sachs Group, Inc. - Quantitative Strategy Group

Chris Telmer

Carnegie Mellon University - David A. Tepper School of Business

Date Written: June 1996

Abstract

Perhaps the most puzzling feature of currency prices is the tendency for high interest rate currencies to appreciate, when the expectations hypothesis suggests the reverse. Some have attributed this forward premium anomaly to a time-varying risk premium, but theory has been largely unsuccessful in producing a risk premium with the requisite properties. We characterize the risk premium in a general arbitrage-free setting and describe the features a theory must have to account for the anomaly. In affine models, the anomaly requires either that state variables have asymmetric effects on state prices in different currencies or that we abandon the common requirement that interest rates be strictly positive.

Suggested Citation

Backus, David K. and Foresi, Silverio and Telmer, Christopher I., Affine Models of Currency Pricing (June 1996). NBER Working Paper No. w5623. Available at SSRN: https://ssrn.com/abstract=4127

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Silverio Foresi

Goldman Sachs Group, Inc. - Quantitative Strategy Group ( email )

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New York, NY 10005
United States
(212) 357-3508 (Phone)

Christopher I. Telmer

Carnegie Mellon University - David A. Tepper School of Business ( email )

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Pittsburgh, PA 15213-3890
United States
(412) 268-8838 (Phone)
(412) 268-6837 (Fax)

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