Department of Economics

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

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Presentation by: Peter Bakke Lars Bryld-Petersen

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Monday, October 31st 2011

October 31st 2011 . ted og eltet for ”Enhedens Sidefod Monday.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 punktpå brug rykning venstrekst uden stilling. dsæt” > ed / . mindsk ng ndre ns navn” og dato”: nulinjen.

dsæt” > ed / . NZD. CAD.Department of Economics ft her Uncovered Interest Parity Definition: rter uden stilling punktpå brug rykning venstrekst uden stilling. October 31st 2011 . USD nulinjen. GBP. with Japan as domestic country and the following six countries as foreigns: •  AUD. 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. EUR. ted og eltet for ”Enhedens Sidefod Monday.

dsæt” > ed / . ted og eltet for ”Enhedens Sidefod Monday. October 31st 2011 .Department of Economics Motivation de: og klik på dsæt ndre ns navn” og dato”: nulinjen.

October 31st 2011 . mindsk ng •  That is. dsæt” > ed / . 2} with the probabilities in the transition matrix P ndre ns navn” og dato”: nulinjen. st takes values in {1.Department of Economics ft her Two-state stochastic volatility Our model for exchange rate returns: rter uden stilling punktpå brug rykning venstrekst uden stilling. ted og eltet for ”Enhedens Sidefod Monday.

October 31st 2011 . dsæt” > ed / . mindsk ng ndre ns navn” og dato”: nulinjen.Department of Economics ft her OLS analysis of mean returns rter uden stilling punktpå brug rykning venstrekst uden stilling. ted og eltet for ”Enhedens Sidefod Monday.

ted og eltet for ”Enhedens Sidefod Monday. for some guess on the parameters •  M-step •  Maximize the likelihood-function by calculating the first order conditions venstrekst uden stilling.Department of Economics ft her EM-algorithm based estimation of the model The parameters to be estimated in our model is. rter uden stilling punktpå brug rykning •  Two-step estimation •  E-step: •  Calculate conditional expectations of the likelihood function. October 31st 2011 . dsæt” > ed / . mindsk ng ndre ns navn” og dato”: nulinjen.

mindsk ng ndre ns navn” og dato”: nulinjen.Department of Economics ft her “Closed form” estimates rter uden stilling punktpå brug rykning venstrekst uden stilling. ted og eltet for ”Enhedens Sidefod Monday. October 31st 2011 . dsæt” > ed / .

ted og eltet for ”Enhedens Sidefod Monday. dsæt” > ed / .Department of Economics de: og klik på dsæt ndre ns navn” og dato”: nulinjen. October 31st 2011 .

dsæt” > ed / . October 31st 2011 .Department of Economics de: og klik på dsæt ndre ns navn” og dato”: nulinjen. ted og eltet for ”Enhedens Sidefod Monday.

Department of Economics Transition matrices Monday. October 31st 2011 .

mindsk ng ndre ns navn” og dato”: nulinjen. ted og eltet for ”Enhedens Sidefod Monday. carry trade profitability •  Sharpe ratio rter uden stilling punktpå brug rykning venstrekst uden stilling. October 31st 2011 . dsæt” > ed / .Department of Economics ft her From here… •  •  Test assumptions used in estimation Implications of our findings wrt.