Test for Risk Premia in Foreign Exchange Markets (GBP/CHF)

Paper instructions:
TASK :
Test for Risk Premia in Foreign Exchange Markets (GBP/CHF)

FT.com (UK) reports spot and forward exchange rate of CHF against Pound. You can download these data from FT.com data archive: http://markets.ft.com/RESEARCH/Markets/Data-Archive.

Use the data of last date for each month as monthly data, collect spot rate (denoted as St), 1-month forward rate (denoted as Ft), and 3-month forward rate (denoted as F3) from 31 August 2009 to 31 July 2014. Make use of the STATA programs (or equivalent) to prepare to answer the following:

a) Produce a graph of the £/c exchange rate, where c denotes the currency you have chosen. Provide your comments on the graph. Any abnormal observations (“outliers”)? Double check with the FT.com data archive to make sure these abnormal observations are not due to the errors you made during the data collection process. If they are not error inputs, are there any unexpected events (news) associated with these observations?

b) Produce a graph for monthly forward discount (st – ft ) and provide your comments, where st = ln(St ) and ft = ln(Ft ).

c) Produce a summary statistics table for the variables in your dataset.

d) Download STATA program „ex_risk_premia.do‟ and modify the program to run the following regressions:

.        Test for the existence of a risk premium on the 1-month horizon by including the lagged forward discount as a regressor:

st -ft-1 =a+b(st-1-ft-1)+et

.        Test for the existence of a risk premium on the 3-month horizon by including the 3-month forward discount, lagged three months, as a regressor:

s-f3 =a+b(s -f3)+e t t-3 t-3 t-3 t

where  f3 =ln(F3 ) t-3 t-3

e) Interpret your regression results. Do you find evidence for the presence of risk premia in foreign exchange market? Provide your comments on uncovered interest rate parity (UIP) and covered interest rate parity (CIP) base on your regression results.

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