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|Title:||A hidden Markov approach to the forward premium puzzle|
|Citation:||International Journal of Theoretical and Applied Finance, 2006; 9(7):1009-1020|
|Publisher:||World Scientific Publishing Co Pte Ltd|
|Robert J. Elliott; Bing Han|
|Abstract:||A Hidden Markov Chain (HMC) is applied to study the forward premium puzzle. The weekly quotient of the interest rate differential divided by the log exchange rate change is modeled as a Hidden Markov process. Compared with existing standard approaches, the Hidden Markov approach allows a detailed analysis of the puzzle on a day-to-day basis while taking into full account the presence of noise in the observations. Two and three state models are investigated. A three-state HMC model performs better than two-state models. Application of the three-state model reveals that the above quotient is mostly zero, and hence leads to the rejection of the uncovered interest rate parity hypothesis.|
|Keywords:||Hidden Markov models|
uncovered interest rate parity.
|Rights:||© 2006 World Scientific Publishing Company|
|Appears in Collections:||Applied Mathematics publications|
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