This paper describes tests for time-varying risk premia associated with foreign currency futures positions. Empirical implementation with daily data uses the conditional capital asset pricing model in which the covariance risk implied by the consumption-based intertemporal asset pricing model is replaced by the conditional beta of the position with respect to the excess returns from a benchmark portfolio. Generalized ARCH specifications are used for the conditional heteroscedasticity in the innovations so that the conditional betas vary through time along with the conditional second moments.
Two sets of tests are made. In the first set, significantly positive risk premia are found in the futures prices themselves for all five foreign currencies examined. The conditional risk premia vary substantially across currencies and over time. The second set, made with basis positions, is concerned with a potential difference between the systematic risk in the futures prices and that in the underlying spot currency prices. No evidence of such incremental risk is found for the futures prices for the three remaining currencies. This basis risk is small relative to the risk premia in the futures prices alone.
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