A natural generalization of the ARCH (Autoregressive Conditional Heteroskedastic) process introduced in Engle (1982) to allow for past conditional variances in the current conditional variance equation is proposed. Stationarity conditions and autocorrelation structure for this new class of parametric models are derived. Maximum likelihood estimation and testing are also considered. Finally an empirical example relating to the uncertainty of the inflation rate is presented.

We wish to thank Julia Marsh and Julia Lowell for research assistance, and Dr. Franz Scholl of the Bundesbank for making the daily intervention data available. This paper is part of NBER's research program in International Studies. Any opinions expressed are those of the authors and not those of the National

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One of the most puzzling features of currency prices is the tendency for high interest rate currencies to appreciate. Some have attributed this forward premium anomaly to a time-varying risk premium, but theory has been largely unsuccessful in producing a risk premium with the requisite properties. We characterize the risk premium in both general and affine arbitrage-free settings and describe the features a theory must have to account for the anomaly. In affine models, the anomaly requires either that state variables have asymmetric effects on state prices in different currencies or that we abandon the requirement that interest rates be strictly positive.

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The relation between the volatilities of pricing kernels associated with different currencies and the volatility of the exchange rate between the currencies is derived under the assumption of integrated capital markets, and the volatilities of the pricing kernels are related to the foreign exchange risk premium. Time series of pricing kernel volatilities are estimated from panel data on bond yields for five major currencies using a parsimonious term structure model that allows for time varying pricing kernel volatilities. The resulting estimates are used to test hypotheses about the relation between the volatilities of the pricing kernels in different currencies and the volatility of the exchange rate. As predicted, time variation in foreign exchange risk premia is found to be related to time variation in both the volatility of the pricing kernels and the volatility of exchange rates: the estimated pricing kernel volatilities can account for the forward premium puzzle in an ‘average ’ sense across exchange rates. International Capital Markets and Foreign Exchange Risk 1

Are frequent changes in freely floating exchange rates attributable to stabilising speculation reflecting changes in the fundamental determinants of currencies; or to destabilising behaviour of various kinds, driving prices away from fundamentals, and creating "excess " volatility? This paper, motivated by the need to assess appropriate tests for efficiency for the growing range of liberalised and liberalising foreign exchange markets in Sub-Saharan African countries, has the following objectives: (i) briefly to survey the empirical methodology for testing market efficiency in the forex market, with an emphasis on integrating the new cointegration methodology; (ii) highlighting the significant data difficulties in empirical work, given controls and frequent structural breaks, for the use of these techniques in Africa; (iii) illustrating the way in which some of these techniques can be applied in South Africa; and (iv) suggesting further research on efficiency that could be carried out using similar data. 1 1.

This paper uses currency futures prices to test the joint null hypotheses of rational expectations and absence of a time varying risk premium in the foreign exchange market. We find no linear predictability in the logarithm of futures price changes, either using its own past or past interest differentials. Also we establish that there is no nonlinear predictability in log price changes, conditioning on its own past, or past interest rate differentials. Thus, if a time varying risk premium exists in currency futures market, it is not related to its own past or past interest rate differentials.

This paper studies the forward premium puzzle in an environment where private agents do not perfectly observe the shocks that drive monetary policy. Private agents optimally update their conditional expectations by means of the Kalman filter. The transition dynamics associated with Kalman filtering lead to fixed time-effects and conditional heteroskedasticity in the forward premium regression. We provide evidence for some of the theoretical properties of the model, and find that our empirical specification significantly weakens the forward premium puzzle. In particular, a 1 percent increase in the 1-month interest di¤erential is expected to be accompanied by an additional 0.34 percent depreciation of the currency in the following month.