Can a Habit Formation Model really explain the forward premium anomaly?
Verdelhan (2009) shows that if one is to explain the foreign exchange forward premium behavior using Campbell and Cochrane (1999)'s habit formation model one must specify it in such a way to generate pro-cyclical short term risk free rates. At the calibration procedure, we show that this is only possible in Campbell and Cochrane's framework under implausible parameters speci cations given that the price-consumption ratio diverges in almost all parameters sets. We, then, adopt Verdelhan's shortcut of xing the sensivity function (st) at its steady state level to attain a nite value for the price-consumption ratio and release it in the simulation stage to ensure pro-cyclical risk free rates. Beyond the potential inconsistencies that such procedure may generate, as suggested by Wachter (2006), with pro- cyclical risk free rates the model generates a downward sloped real yield curve, which is at odds with the data.
Year of publication: |
2009-05-12
|
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Authors: | Costa, Carlos Eugênio da ; Vasconcelos, Jivago X. |
Institutions: | FGV/EPGE Escola Brasileira de Economia e Finanças, Fundação Getulio Vargas (FGV) |
Saved in:
freely available
Extent: | application/pdf |
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Series: | Economics Working Papers (Ensaios Economicos da EPGE). - ISSN 0104-8910. |
Type of publication: | Book / Working Paper |
Language: | English |
Notes: | Number 692 |
Source: |
Persistent link: https://www.econbiz.de/10005009218
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