A multivariate generalized ARCH approach to modeling risk premia in forward foreign exchange rate markets
نویسنده
چکیده
Assuming that daily spot exchange rates follow a martingale process. we derive the implied time series process for the vector of 30-day forward rate forecast errors from using weekly data. The conditional second moment matrix of this vector is modeled as a multivariate generalized ARCH process. The estimated model is used to test the hypothesis that the risk premium is a linear function of the conditional variances and covariances as suggested by the standard asset pricing theory literature. Little support is found for this theory; instead lagged changes in the forward rate appear to be correlated with the ‘risk premium.’
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