Measuring the Euro Exchange Rate Risk Premium: The Conditional International CAPM Approach

30 Pages Posted: 2 May 2003

See all articles by Lorenzo Cappiello

Lorenzo Cappiello

European Central Bank (ECB)

Olli Castren

European Central Bank (ECB)

Jarkko P. Jääskelä

Reserve Bank of Australia

Date Written: January 2003

Abstract

This paper derives measures for the bilateral euro exchange rate risk premia vis-a-vis the US dollar and the UK pound sterling, as well as the US and the UK equity market risk premia using the perspective of a european investor. We carry out the estimations applying the conditional International Capital Asset Pricing Model (ICAPM). The ICAPM is estimated for both constant and time-varying prices of risk, using weekly data on the equity and foreign exchange returns for Europe, the UK and the US. In estimating the time-varying prices of risk, we propose a new set of instrumental variables that take both business cycle and market volatility considerations into account. Consequently, our risk premium estimates are more intuitive, picking up most of the individual events that moved the markets between 1986 and 2001.

Keywords: exchange rate and equity risk premium, international asset pricing, multivariate GARCH

JEL Classification: C32, C52, G12

Suggested Citation

Cappiello, Lorenzo and Castren, Olli and Jääskelä, Jarkko P. P., Measuring the Euro Exchange Rate Risk Premium: The Conditional International CAPM Approach (January 2003). Available at SSRN: https://ssrn.com/abstract=391986 or http://dx.doi.org/10.2139/ssrn.391986

Lorenzo Cappiello (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 8765 (Phone)

Olli Castren

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Jarkko P. P. Jääskelä

Reserve Bank of Australia ( email )

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