Recent Estimates of Time-Variation in the Conditional Variance and in the Exchange Risk Premium
The optimal-diversification model of investors' portfolio behavior can give a linear relationship between the exchange risk premium and the conditional exchange rate variance. This note surveys recent empirical work that allows for the conditional variance itself, and therefore the risk premium, to vary over time. In particular, it examines the implications of recent empirical estimates for earlier arguments, based on the assumption that the conditional variance was constant over time, that the exchange risk premium had to be small in magnitude and variability.
Journal of International Money and Finance, Vol. 7, pp. 115-125, (1988). citation courtesy of
Reprinted in On Exchange Rates, J. Frankel, MIT Press, Cambridge, 1993