NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

A Utility Based Comparison of Some Models of Exchange Rate Volatility

Kenneth D. West, Hali J. Edison, Dongchul Cho

NBER Technical Working Paper No. 128
Issued in November 1992
NBER Program(s):International Finance and Macroeconomics, Asset Pricing

When estimates of variances are used to make asset allocation decisions, underestimates of population variances lead to lower expected utility than equivalent overestimates: a utility based criterion is asymmetric, unlike standard criteria such as mean squared error. To illustrate how to estimate a utility based criterion, we use five bilateral weekly dollar exchange rates, 1973-1989, and the corresponding pair of Eurodeposit rates. Of homoskedastic, GARCH, autoregressive and nonpararnetric models for the conditional variance of each exchange rate, GARCI-J models tend to produce the highest utility, on average. A mean squared error criterion also favors GARCH, but not as sharply.

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Document Object Identifier (DOI): 10.3386/t0128

Published: Journal of International Economics 1993, vol. 35, no.1, pp. 23-46

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