The Intertemporal Relation between Expected Return and Risk on Currency
37 Pages Posted: 13 Mar 2009 Last revised: 27 Feb 2012
Date Written: November 30, 2009
Abstract
The literature has so far focused on the risk-return tradeoff in equity markets and ignored alternative risky assets. This paper examines the presence and significance of an intertemporal relation between expected return and risk in the foreign exchange market. The paper provides new evidence on the intertemporal capital asset pricing model by using high-frequency intraday data on currency and by presenting significant time-variation in the risk aversion parameter. Five-minute returns on the spot exchange rates of the U.S. dollar vis-a-vis six major currencies (the Euro, Japanese Yen, British Pound Sterling, Swiss Franc, Australian Dollar, and Canadian Dollar) are used to test the existence and significance of a daily risk-return tradeoff in the FX market based on the GARCH, realized, and range volatility estimators. The results indicate a positive, but statistically weak relation between risk and return on currency.
Keywords: foreign exchange market, ICAPM, high-frequency data, time-varying risk aversion
JEL Classification: G12, C13, C22
Suggested Citation: Suggested Citation
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