P Mansfield

Rationality and the Risk Premium on the Australian dollar

A Model of the forward rate error of the USD/AUD spot exchange rate is fitted to daily data for the period 15th December 1983 to 31st December 1991. This provides a data set of 2034 daily trading observations. Explanations of the forecast error include a risk premium represented by a constant plus the conditional variance generated from a GARCH (1,1)-M analysis of the error process and information variables in the form of lagged forward rate errors. The following conclusions are drawn form estimates for the full sample: the USD/AUD spot rate is subject to a constant premium: there is little evidence to support a time varying component and the market is influenced by lagged forward errors. Sub period estimation confirms these results, although a time varying premium is evident prior to the February 1985 depreciation. The economic implications of these findings are discussed. [F31]

The relationship between the trading activities of the Reserve Bank of Australia and movements in the value of the Australian dollar

Abstract This paper explores the relationships between changes in the value of the Australian dollar and the trading activities of the Reserve Bank of Australia over the ten year period December 1983 through December 1993. In particular, it identifies the existence or otherwise of Granger-causality between returns and trading activity at various sampling intervals. The following results are obtained: knowledge of the daily trading activities of the Reserve Bank improves the prediction of the daily returns gained by holding the Australian dollar. On the other hand, if weekly data is used, the direction of ‘causality’ is reversed: knowledge of weekly returns improves the prediction of the weekly trading activities of the Reserve Bank. The analysis of monthly data finds no evidence of Granger-causality in either direction: knowledge of monthly returns does not improve the prediction of Reserve Bank trading activities, and knowledge of the monthly trading activities does not improve the prediction of monthly returns gained from holding the Australian dollar. An attempt is made to infer Reserve Bank trading policy and its effectiveness. Although a case can be made that the Bank uses weekly movements in the value of the dollar as an input into its trading decisions, our analysis suggests that Reserve Bank trading affects the movement of the dollar on a short (daily) time scale only; ultimately, market forces prevail over longer time periods.

GARCH in question ... and as a benchmark

Abstract GARCH models of volatility are ubiquitous. Over the past twelve years, the GARCH industry has produced an almost infinite number of volatility time series from an extremely wide range of return series. The main purpose of this paper is to revisit the notion of volatility. Although we stop just short of questioning the necessity (and certainly the success) of GARCH, we demonstrate that for at least one type of data—long term interest rates—it is possible to essentially reproduce GARCH volatility time series with simple moving averages of deviations from mean return. We also demonstrate (empirically) a functional relationship between GARCH(1,1) parameters and the optimal moving average window width. At the present time these results are based on the utilisation of GARCH volatility as a benchmark against which we select the optimal number of terms in the simple moving average representation. One possible avenue of research that might lead to the removal of this requirement is suggested. An interesting applied result that emerged from our analysis is this: from 1952 to the present, USA interest rate volatility has the highest overall cross-correlation with the interest rate volatilities of other countries.