TY - JOUR
T1 - Stochastic risk premiums, stochastic skewness in currency options, and stochastic discount factors in international economies
AU - Bakshi, Gurdip
AU - Carr, Peter
AU - Wu, Liuren
N1 - Funding Information:
We thank G. William Schwert (the editor), Nasir Afaf, Doron Avramov, David Backus, David Bates, Charles Cao, Zhiwu Chen, Mike Chernov, Peter Christoffersen, Pat Dennis, Emanuel Derman, Joost Driessen, Jin-chuan Duan, Bruno Dupire, Rob Engle, Stephen Figlewski, Rene Garcia, Brian Healy, Steve Heston, Haitao Li, Kris Jacobs, Bob Jarrow, Frank de Jong, Paul Kupiec, Pete Kyle, Nengjiu Ju, Nikunj Kapadia, Hosssein Kazemi, Jun Liu, Mark Loewenstein, Dilip Madan, Pascal Maenhout, Stewart Mayhew, Nour Meddahi, Ludovic Phalippou, Roberto Rigobon, John Ryan, Ken Singleton, Harvey Stein, Arun Verma, Frank Zhang, and seminar participants at the 2005 Annual Derivatives Securities and Risk Management Conference at the Federal Deposit Insurance Corporation, Bloomberg LP, Courant Institute, 2005 Financial Econometrics Conference in Montreal, University of Maryland, University of Massachusetts at Amherst, 2005 University of Virginia Conference on Probability, Derivatives, and Asset Pricing, 2005 Empirical Asset Pricing Retreat in Amsterdam, and 2005 Western Finance Association meetings in Portland for comments. We are especially grateful for the detailed feedback of an anonymous referee. Any remaining errors are ours. Bakshi acknowledges partial support from the CIBER grant given to the Smith Business School at Maryland.
Copyright:
Copyright 2007 Elsevier B.V., All rights reserved.
PY - 2008/1
Y1 - 2008/1
N2 - We develop models of stochastic discount factors in international economies that produce stochastic risk premiums and stochastic skewness in currency options. We estimate the models using time-series returns and option prices on three currency pairs that form a triangular relation. Estimation shows that the average risk premium in Japan is larger than that in the US or the UK, the global risk premium is more persistent and volatile than the country-specific risk premiums, and investors respond differently to different shocks. We also identify high-frequency jumps in each economy but find that only downside jumps are priced. Finally, our analysis shows that the risk premiums are economically compatible with movements in stock and bond market fundamentals.
AB - We develop models of stochastic discount factors in international economies that produce stochastic risk premiums and stochastic skewness in currency options. We estimate the models using time-series returns and option prices on three currency pairs that form a triangular relation. Estimation shows that the average risk premium in Japan is larger than that in the US or the UK, the global risk premium is more persistent and volatile than the country-specific risk premiums, and investors respond differently to different shocks. We also identify high-frequency jumps in each economy but find that only downside jumps are priced. Finally, our analysis shows that the risk premiums are economically compatible with movements in stock and bond market fundamentals.
KW - Currency options
KW - Foreign exchange rate dynamics
KW - International economy
KW - Stochastic discount factors
KW - Stochastic risk premium
KW - Stochastic skewness
KW - Time-changed Lévy processes
KW - Unscented Kalman filter
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U2 - 10.1016/j.jfineco.2006.12.001
DO - 10.1016/j.jfineco.2006.12.001
M3 - Article
AN - SCOPUS:36849057641
VL - 87
SP - 132
EP - 156
JO - Journal of Financial Economics
JF - Journal of Financial Economics
SN - 0304-405X
IS - 1
ER -