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Time‐varying/sign‐switching risk perception on foreign exchange markets
Author(s) -
Gallo Giampiero M.,
Pacini Barbara
Publication year - 1998
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/(sici)1099-1158(199807)3:3<241::aid-ijfe79>3.0.co;2-d
Subject(s) - econometrics , economics , volatility (finance) , autoregressive conditional heteroskedasticity , estimator , nonparametric statistics , currency , instrumental variable , sign (mathematics) , financial economics , monetary economics , mathematics , statistics , mathematical analysis
In this paper we analyse the consequences of considering risk‐augmented specifications of the relationship between spot and forward rates. Previous parametric specifications such as the GARCH‐M provided disappointing results possibly due to the high degree of persistence of the estimated process for conditional volatility. We propose a more flexible semiparametric approach where a nonparametric estimator of the conditional volatility is used as an instrumental variable, and we apply it on six major currencies vis‐à‐vis the Deutsche Mark (monthly data). An interesting picture of shifting risk perception arises when an indicator of market sentiment in the form of trading signals to purchase or sell a currency is inserted in the model. © 1998 John Wiley & Sons, Ltd.