Department of Economics

ift her

Two-State Stochastic Volatility in Exchange Rate Returns and the Profitability of Carry Trades

holder KU-

Presentation by: Peter Bakke Lars Bryld-Petersen

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

ft her

Outline
Uncovered Interest Parity Motivation for using a stochastic volatility approach Two-state volatility stochastic volatility theory Model Results Implications

rter uden stilling

punktp brug rykning

venstrekst uden stilling, mindsk ng

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

ft her

Uncovered Interest Parity

Definition:

rter uden stilling

punktp brug rykning

venstrekst uden stilling, mindsk ng

In our data are the interest returns defined as 1 month deposit rate and monthly spot exchange rates Exchange rates are defined as amount of JPY needed to buy one unit of foreign currency

ndre ns navn og dato:

We are using these six currencies, with Japan as domestic country and the following six countries as foreigns: AUD, CAD, EUR, GBP, NZD, USD

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

Motivation

de: og klik p dst

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

ft her

Two-state stochastic volatility

Our model for exchange rate returns:

rter uden stilling

punktp brug rykning

venstrekst uden stilling, mindsk ng

That is, st takes values in {1, 2} with the probabilities in the transition matrix P

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

ft her

OLS analysis of mean returns

rter uden stilling

punktp brug rykning

venstrekst uden stilling, mindsk ng

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

ft her

EM-algorithm based estimation of the model

The parameters to be estimated in our model is,

rter uden stilling

punktp brug rykning

Two-step estimation E-step: Calculate conditional expectations of the likelihood function, for some guess on the parameters M-step Maximize the likelihood-function by calculating the first order conditions

venstrekst uden stilling, mindsk ng

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

ft her

Closed form estimates

rter uden stilling

punktp brug rykning

venstrekst uden stilling, mindsk ng

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

de: og klik p dst

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

de: og klik p dst

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011

Department of Economics

Transition matrices

Monday, October 31st 2011

Department of Economics

ft her

From here
Test assumptions used in estimation Implications of our findings wrt. carry trade profitability Sharpe ratio

rter uden stilling

punktp brug rykning

venstrekst uden stilling, mindsk ng

ndre ns navn og dato:

nulinjen, dst > ed / . ted og eltet for Enhedens Sidefod

Monday, October 31st 2011