In this paper we investigate the relationship between risk premium and a time-varying conditional variance of spot rate using weekly Swiss franc/US dollar exchange-rate data. First, we apply an EGARCH-in-mean framework to test the unbiasedness hypothesis of the forward rate with a volatility dependent risk premium. The corresponding estimates point to no significant influence of volatility on the risk premium, and reject the unbiasedness hypothesis. Second, we apply a seminonparametric, nonlinear impulse-response analysis to the spot-rate change and the forward premium. This framework allows us to analyze the risk premium/volatility relationship without using a specific, parametric model such as EGARCH-in-mean. The latter analysis confirms the negative EGARCH-in-mean results with respect to the risk premium/volatility relationship, although the volatility dynamics estimated is clearly different from that implied by the EGARCH estimate. Moreover, the forward premium has a nonlinear dynamic influence on the spot rate, whereas the converse is not true.
©2011 Walter de Gruyter GmbH & Co. KG, Berlin/Boston
