Working Paper

A utility based comparison of some models of exchange rate volatility

Abstract: When estimates of variances are used to make asset allocation decisions, underestimates of population variances lead to lower expected utility than equivalent overestimates: a utility based criterion is asymmetric, unlike standard criteria such as mean squared error. To illustrate how to estimate a utility based criterion, we use five bilateral weekly dollar exchange rates, 1973-1989, and the corresponding pair of Eurodeposit rates. Of homoskedastic, GARCH, autoregressive and nonparametric models for the conditional variance of each exchange rate, GARCH models tend to produce the highest utility, on average. A mean squared error criterion also favors GARCH, but not as sharply.

Keywords: Econometric models; Foreign exchange rates;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 1993

Number: 441