WHY ARE RETURNS ON SWISS FRANC ASSETS SO LOW?

Transcription

1 WHY ARE RETURNS ON SWISS FRANC ASSETS SO LOW? Peer Kugler and Bearce Weder Ths verson: July 2005 Absrac As s well known, he uncovered neres rae pary fals n he shor run bu usually holds n he long run. Ths paper analyses he long and shor run neres rae pary of 0 mayor OECD currences and fnds ha here s a long run falure of he uncovered neres rae pary condon for he Swss Franc. Afer correcng for exchange rae changes, mean reurns on Swss asses have been sgnfcanly lower han n oher currences, an anomaly no found n any oher major currency. The long run reurn dfferenal has been sable over he las 20 years, ransory srucural breaks are only found n mes of currency urmol. We sugges ha he reurn anomaly may be due o an nsurance premum agans very rare caasrophc evens, such as a major war. Supporng evdence for hs hypohess comes from wo emprcal fndngs: Frs, we show ha he reurn dfferenal s negavely affeced by large unexpeced geo-polcal evens. Second we examne hsorcal daa on neres raes dfferenals and show ha he abnormally low level of Swss reurns arses afer he frs world war only. JEL Classfcaon: E43, E44, G5 Auhors E-mal: Peer.Kugler@unbas.ch, Bearce.Weder@un-manz.de ) Deparmen of Economcs, Unversy of Basle, Swzerland and Deparmen of Economcs Unversy of Manz. For helpful commens we hank Mchael Bordo, Anu Pann Murshd, Anne Klenewefers Lehner as well as an annoymous referee and, Mahas Hoffmann he edor responsble for hs paper. We hank Anu Pann Murshd for sharng daa. Fnancal suppor from he WWZ Förderveren s graefully acknowledeg. Forhcomng n Appled Economcs Quarerly

2 . Inroducon A well known puzzle of foregn exchange markes s he anomalous response of exchange raes o neres rae dfferenals. The leraure ha has documened hs shor run falure of he uncovered neres rae pary ypcally fnds ha an ncrease n he domesc neres of one percen s followed by an apprecaon--raher han a deprecaon--of he domesc currency a he annual rae of almos one percen or even more. Thus he nave sraegy of nvesng n he currency offerng a hgher neres rae promses abnormally excess reurns. However, hs anomaly seems o exs only n he shor run. The uncondonal mean of he apprecaon rae of he US Dollar agans major currences does no seem o be sascally dfferen from ha of he neres rae dfferenal (Hodrck, 2000). Therefore we can conclude ha he falure of UIP n he shor run (forward premum puzzle) offers only shor run reurn opporunes whch are subjec o a consderable rsk gven he hgh volaly of exchange raes 2 In hs paper we show ha hs concluson, whch s vald for mos pars of major currences, does no hold for he Swss Franc. Frs, we documen he anomaly ha Swss Franc mean reurns are sascally sgnfcanly lower han he exchange rae change correced reurn on all oher major currences. Second, we show ha he reurn dfferenal has been sable and has no dmnshed over me. Nex we show ha he Swss Franc s by no means specal wh regard o he shor run falure of he uncovered neres rae pary (forward premum puzzle). Therefore, we denfy a puzzle whch presen only n Swss Franc asses and represens a falure of UIP on average over more han 20 years. 3 A popular explanaon for low reurns on Swss Franc asses s relaed o naonal or regulaory feaures of Swzerland (such as he Swss bankng secrecy). However, hs explanaon s no convncng snce we fnd he reurn anomaly n Euromarke deposs, whch are ousde Swss legslaon. Froo (990) fnds ha he average coeffcen of 75 sudes of he forward dscoun bas s More recen surveys ofen presen coeffcen esmaes below for major currences, Engle (996), Hodrck (2000). 2 Ths s he concluson drawn by Cochrane (999) n hs survey on New Facs n Fnance. 3 Furhermore, an analyss of sources of real reurn dfferenals (afer correcng for exchange rae changes) shows ha hey alos can be arbued mosly o he falure of uncovered neres rae pary, raher han a falure of relave purchasng power pary. See Kugler and Weder (2004). 2

3 We offer an alernave explanaon based on a peso problem: Invesors may be accepng somewha lower reurns n he expecaon ha he Swss Franc would apprecae n he even of a large scale caasrophe. Snce such evens are rare and have no been observed n he pas 20 years s dffcul o es he hypohess for hs perod. Neverheless we fnd suppor for hs hypohess from wo emprcal fndngs: frs, we show ha he reurn dfferenal s negavely affeced n he shor run by large unexpeced geopolcal evens, such as he fall of he Berln Wall, or he sudden deah of Sove leaders. Second we presen hsorcal evdence on neres raes dfferenals durng he pre-war and ner-war perod. These show ha he abnormally low level of Swss reurns arses afer he frs world war only.. 4 The paper s organzed as follows. Secon 2 dscusses he mehodology and he daa. Secon 3 presens he resuls and secon 4 concludes. 2. Mehodology and Daa For each counry we have hree varables of neres: The neres rae (), he change n he log of he nomnal exchange rae defned as he home currency prce of he foregn currency, ( s) and he CPI Inflaon rae (π). Foregn varables are denoed by. Frs of all we wll consder he mean of he dfferenal of he one monh nomnal reurns n he foregn and home currency correced for exchange rae changes: d, =, + s, Accordng o a weak (long run) form of UIP he (uncondonal) mean value of hs varable should be zero. 4 Our soluon o he puzzle s akn o he one Joron and Goezmann (999), offer for he equy premum puzzle. They showed ha he equy prce puzzle also dsappears for counres ha suffered caasrophc evens, n parcular he nerrupon of he sock exchange durng he wars. Furhermore, hs explanaon for low reunrs s also compable wh a porfolo approach, whch sresses he covarance of reurns. In Kugler and Weder (2004) we show ha some Swss franc asses have a very low or even negave correlaon wh he reurns of oher rsky asses. 3

4 Nex we ake no accoun he dynamcs of he varables of neres. Frs we consder an unvarae model: We sudy a sysem of AR() equaons for all nne rae of reurn dfferenals. γ δ, + s, = + (, 2 + s, 2 ) + e, Ths allows us o ake no accoun he weak auocorrelaon of he reurn dfferenal of neres and o es jonly he hypoheses concernng he nerceps of hese regressons whch deermnes he mean rae of reurn dfferenals. Moreover we es he srucural sably of hese equaons esmaed for he nomnal reurn dfferenals. To hs end we apply he recenly developed mulple break es wh unknown break daes publshed by Ba and Perron (998). Ths approach sequenally deermnes he break pon accordng o he maxmal F-sasc for all possble break pons. Ths means ha frs he sample s spl n wo pars by hs creron. Then he same approach s appled o he wo subsamples and so on. We consder a maxmum of fve break pons and a mnmum dsance of four monhs beween wo breaks. The es s used n wo varans: Frs sably wh respec only o he nercep erm s consdered. Second nercep and slope coeffcen are esed jonly. In a nex sep we es for he equaly of he uncondonal mean of he log exchange rae change and he neres rae dfferenal n a bvarae VAR() framework. Ths approach should gve a more powerful es of he hypohess of neres as accouns for he dynamc nerrelaonshp of he wo varables. Denong he whe nose error erms of he (sable) VAR() sysem by ε we can wre our model as follows: s ( ) = c = c 2 s 2 s 2 ( 22 ( ) + ε ) + ε 2 Gven hs model we can easly derve he uncondonal means of he wo varables as 4

5 E( s ) E( ( a22 ) c 2c = ( a )( a ) a ( a) c2 2c ) = ( a )( a ) a a a Therefore, he equaly of he wo means can be esed as he followng cross equaon resrcon for our VAR() model ( a c c 22 ) c 2c2 = ( a) 2 2 Ths resrcon s esed usng a lkelhood rao es under he assumpon of normally dsrbued error erms. In a nex sep we examne he well known falure of UIP n he shor run (forward premum puzzle) wh our daa se. Of course hs could be done by esng he correspondng resrcons on he coeffcens of our frs VAR() equaon. 5 As hs puzzle s usually documened n a more resrced smple regresson framework, namely by regressng he log exchange rae change on he lagged neres rae dfferenal and by showng ha he slope coeffcen esmae s negave and sascally dfferen from one, we wll follow hs pracce. However, should be menoned ha he es resuls obaned n he VAR framework are qualavely equal o hose provded by he smple regresson mehod. For he floang rae perod, we check our nerpreaon of he perssenly negave excess reurn of fxed ncome Swss Franc asse as an nsurance agans caasrophc rsks by analyzng he reacon of s condonal mean o varables measurng worldwde rsk and geo-polcal uncerany. 6 The basc dea s ha he apprecaon of he Swss Franc decreases exchange rae correced foregn currency reurns n reacon o ncreased worldwde uncerany wh respec o economc and, n parcular, polcal developmens. World-wde rsk s represened by economc facors as he (log) changes n he ndex of ndusral producon n ndusralzed counres (%IPI) 5 c = 0, a = 0, a2 =. 6 We hank Mahas Hoffmann for suggesng hs analyss. 5

6 and he prce of ol (%POIL) as well as changes n world bond (%GSCIW), sock (MSCIW) and commody marke reurn (CGBIW) ndexes. In addon, we ncluded four dummy varables for represenng unexpeced evens whch are deemed o have ncrease he worldwde polcal uncerany, namely he deah of he Sowje leader Cherneko (March, 985), he Tschernobyl nuclear accden (Aprl 28, 986), he fall of he Berln wall (November 9, 989) and he nvason of Kuwa (Augus 2, 990). These evens where seleced because of her clearly exogenous naure and because hey were large and unexpeced surprses wh a sgnfcan geo-plolcal mpac. The sascal sgnfcance of heses varables on reurn dfferenals s hen esed n he framework of a mulple regresson model for he reurn dfferenals of Swss franc and foregn currency money marke nvesmen usng daa for he perod 985 o 998 for whch all he economc facors ncludng he world bond ndex were avalable. Daa: Ineres raes are monh Euro deposs for 0 currences, namely Belgan Franc (BEF), Canadan Dollar (CAD), Deuschmark (DEM), French Franc (FFR), Ialan Lra (ITL), Japanese Yen (JAP), Duch Gulder (NLG), Pound (UKP), Dollar (USD) and Swss Franc (SFR). The daa source s Daasream for he Euro neres raes, for exchange raes, for world bond (GSCI), sock (MSCI) and commody reurn (CGBI) ndexes. Daa on CPI nflaon, ndusral producon n ndusralzed counres and on ol prces was obaned from IFS. The exchange rae are Dollar raes or cross raes, respecvely. We use wo daa ses. Frs, we use monhly daa se from Ths perod was seleced as nernaonal capal movemens were compleely lberalzed n he counres a he end of he sevenes. 7 The second daa se conans yearly daa on shor erm neres raes (3 monhs) from for seven major counres. 8 We consder evdence from he perod s he classcal gold sandard whch s usually daed from 880 unl he frs Word war n 94, from he ner-war perod wh he resored gold sandard (lased beween 923/26 and 93/36, dependng on he counry) and from he Breon Woods perod. 7 6

7 3. Resuls Table repors he mean values of all 45 reurn dfferenals of our en currences and he sandard errors, where he row ndcaes he home counry. Ths able shows an neresng paern: The Swss Franc s he only currency for whch conssenly a posve nomnal reurn dfferenal s repored,.e. he foregn nvesmen has a hgher mean reurn. Ths dfference s larges wh respec o he Non-European currences and he Lra and lowes wh respec o he DM and he Gulder. For all oher currences we observe changng sgns. Moreover, we should noe ha he sandard errors are raher large reflecng he hgh monh o monh exchange rae varably. Table: Rae of Reurn Dfferenals (afer exchange rae adjusmen), Percen p.a. Mean and Sandard Errors n Parenhess CAD DEM FFR ITL JYN NLG UKP USD SFR BEF 0.8 (2.7) (0.56) 0.53 (0.69).76 (.42).22 (2.49) (0.55).3 (2.08) 0.48 (2.68).88 (.22) CAD -.23 (2.74) 0.35 ( (2.56).04 (2.99) -.06 (2.76) 0.95 (2.63) 0.30 (.09) 2.06 (3.0) DEM.58 (0.60) 2.8 (.37) 2.27 (2.49) 0.7 (0.37) 2.8 (2.09).53 (2.68) 0.83 (.09) FFR.23 (.39) 0.69 (2.47) -.4 (0.59) 0.60 (2.06) (2.6) 2.4 (.2) ITL (2.72) (.38) (2.07) -.28 (2.56) 3.64 (.85) JYN -2.0 (2.48) (2.28) (2.87) 3.0 (2.49) NLG 2.0 (2.02).36 (2.67).00 (.08) UKP (2.63) 3.0 (2.27) USD 2.36 (2.93) Now le us focus our analyss on he dfference beween he nne oher currences and he Swss Franc rae of reurns. Table 2 shows he resuls of a sysem of AR() equaons for all nne rae of reurn dfferenals. Ths allows us o ake no accoun he weak auocorrelaon of he 8 We hank Mchael Bordo for provdng hs daa se. 7

8 varables of neres and o es jonly hypoheses concernng he nerceps of hese regressons whch deermnes he mean rae of reurn dfferenals. Table2: Resuls from AR() Models for Nomnal Reurn Dfferenals, Swss Franc vs-à-vs 9 Currences, Monhly Daa ,, + s, = γ + δ (, 2 + s, 2 ) + e, OLS-Esmaes, Sandard Errors n Parenheses Currency γ δ BEF 2.08 (.26) CAD 2.56 (3.03) DEM.39 (.4) FFR 2.72 (.25) ITL 4.8 (.85) JAP.67 (2.43) NLG.64 (.3) UKP 3.77 (2.27) USD 2.8 (2.98) (0.063) 0.02 (0.063) 0.3 (0.063) 0.2 (0.062) ) 0.09 (0.063) 0.3 (0.063) 0.4 (0.063) (0.064) For mos of hese nercep erms he hypohess ha hey are zero canno be rejeced ndvdually. However, he Wald Tes ha all nercep erms are jonly zero can be clearly rejeced a he 5 percen sgnfcance levels. The es sasc, whch s χ square dsrbued wh nne degrees of freedom under he null, ake he value wh a margnal sgnfcance level of Moreover, he hypohess ha all nercep erms are he same canno be rejeced. The correspondng Wald es sascs s 2.44 and he margnal sgnfcance level for he χ-square dsrbuon wh 8 degrees of freedom s Thus, here s no sascally sgnfcan dfference of he mean nomnal reurn dfferenal of all nne currences and he Swss Franc. The same resul 8

9 apples o he posve AR() coeffcens, whch were jonly sascally sgnfcanly dfferen from zero, bu here s no sascally sgnfcan dfference among hese coeffcens. Table 3 presens Ba and Perron s (998) es of he srucural sably of hese equaons esmaed for he nomnal reurn dfferenals. Table 3: Resuls of he Sequenal Ba-Perron Tes for Mulple Srucural Changes AR() Models for Nomnal Reurn Dfferenals, Swss Franc vs-à-vs 9 Currences, Monhly Daa , + s, = γ + δ (, 2 + s, 2 ) + e, Currency Break n nercep Break n nercep and slope Break Pon F-sasc Break pon F-sasc BEF 82: : : : : :6 2.7 CAD 85: : : : : : DEM 82: : : : : : FFR 8: : : : : :5 6.3 ITL 95: : : : : : JYN 8: : : : : : NLG 8: : : : : : UKP 8: : : :9.0 95: : USD 85: : : : : : Sequenal F-Sascs,, and denoes sgnfcance a he 0, 5 and percen level, respecvely, crcal values from Ba/Perron (998, ableii) 9

10 In general we can say ha he nomnal reurn dfferenals seem o be raher sable over me. In parcular hs apples o he dfferenal wh respec o he Belgan Franc, Canadan Dollar, DM, French Franc and he Duch Gulder. For he Ialan Lra we have one or even wo breaks n he frs half of he nnees. If we esmae he mean for he perod 980-9, and we oban values of 5.74, -6.5 and 9.65, respecvely. Thus, we have a nomnal reurn dfferenal n favor of he Swss Franc for he perods of he European currency crses and he wo followng years. Ths manly reflecs he fac ha he Lra dd no deprecae as much as expeced n hs perod. Ineresngly he years before he nroducon of he Euro wness a sharply ncreasng nomnal reurn dfferenal n favor of he Lra, whch probably reflecs a srong degree of uncerany wh respec o he parcpaon of he Lra n he Euro zone. The reurn dfferenal o he Yen and he Pound are very hgh a he begnnng of he eghes (28 percen) and rever hen o a level of.7 and 2.7 percen, respecvely. For he US Dollar we have evdence for breaks n 985 and 987. The mean reurn dfferenal s 7.4 (980-84), (985-87) and.83 (988-98). In he frs subperod hgh US neres raes coupled wh a perssenly apprecang Dollar are clearly he reason for dramac nomnal reurn dfferenal n favor of he Dollar. In he second subperod hs paern s reversed: The Dollar deprecaed much more srongly han refleced by he neres rae dfferenal. Afer hese urbulen epsodes he nomnal reurn dfferenal came back o a normal level slghly below 2 percen. In general we can, however, say ha wh he excepon of he wo relavely shor lved epsodes ( Lra from and he US Dollar from ) here s clear evdence for a perssenly lower nomnal reurn on shor erm Swss Franc asses. Now le us consder he resuls obaned for he hypohess of he equaly of he uncondonal means of he change n he log exchange rae and he neres rae dfferenal n a VAR() framework. Table 4 conans he lkelhood rao sascs for he correspondng cross equaon resrcon, whch follows a ch square dsrbuon wh one degree of freedom under he null of equaly of means. Table4: Lkelhod Rao Tes of he Equaly of he Mean of he log Exchange Rae Change and he Ineres Rae Dfferenal n a VAR() Model, Swss Franc vs-à-vs 9 Currences, Monhly Daa , s ( ( a 22 = c ) c ) = c 2 resrcon : 2 c s 2 2 s 2 = ( a ( 22 ( ) c 2 2 ) + ε c ) + ε 2 0

11 Currency LR-Tes BEF CAD DEM FFR ITL JAP NLG UKP 5.78 USD 6.020, and ndcaes sgnfcance a he 0, 5 and % level, respecvely In seven ou of nne cases he cross equaons resrcon mpled by he equaly of he uncondonal mean of he log exchange rae change and he neres rae dfferenal can be rejeced a he 5% sgnfcance level. For he French Franc and he Ialan Lra he resrcon s rejeced a he 0% sgnfcance level. Therefore he resuls of our VAR framework srenghen he evdence provded by he AR() model for he reurn dfferenals. Indeed he more powerful bvarae es allows o rejec he long run valdy of UIP for ndvdual currences and no only for all currences jonly as n he unvarae framework. We should sress ha he volaon of he long run valdy holds only for he Swss Franc accordng o our ess. The es of he jon hypohess es n he unvarae model for he reurn dfferenal for any oher currency, whch s no repored n deal, canno be rejeced a any reasonable sgnfcance level. The same apples o he VAR cross equaons resrcon es for any par of currences excludng he Swss Franc.

12 Now le us urn o he resuls concernng he UIP n he shor run (forward premum puzzle) obaned wh our daa. In order o conras hese resul wh he long run fndngs repored above we run he smple es regresson for all 45 possble currency pars of our sample. The resuls are repored n able 5. Table 5: Tes Resuls for UIP (Unbasdness of he Forward Premum), Monhly Daa , 0 Currences s = α + β ( + u ) OLS esmaes of β, sandard errors n parenheses CAD DEM FFR ITL JYN NLG UKP USD SFR BEF -.48 (.0) 0.53 (0.9) 0.9 (0.25) (0.38) (0.76) 0.46 (0.9) -. (0.56) -0.9 (0.80) 0.60 (0.37) CAD -.3 (0.9) (079) 0.35 (0.67) (.0) -.94 (0.96) (.08) -.70 (0.55) (0.9) DEM.2 (0.4) 0.23 (0.29) -.74 (.0) -.25 (0.30) -.0 (0.75) (0.8) -.39 (0.79) FFR 0.0 (0.49) 0.45 (0.62).4 (0.5) (0.46) -0.4 (0.66) 0.88 (0.27) ITL 0.23 (0.63) 0.26 (0.30) (0.45) 0.5 (0.63) 0.25 (0.35) JYN -2.4 (.26) (.54) (0.97) (.00) NLG -.42 (0.85) -.62 (0.84) -.49 (0.77) UKP (0.93) -.96 (0.84) USD -.68 (0.77) The paern of he shor run volaons of UIP s clearly dfferen from ha found above for he long run: For he exchange rae of he Swss Franc agans he Belgan Franc, he French Franc and he Ialan Lra here s no shor run UIP falure. The slope coeffcen esmae s posve and no sascally (a he 5 percen level) dfferen from one. For he DM and he Duch Gulder he respecve coeffcen esmae s negave bu no sascally dfferen from zero. The puzzle clearly shows up wh he Canadan Dollar, he Yen, he Pound and he Dollar. The hypohess ha he slope coeffcen for hese currences and he DM as well as Gulder are he same 2

13 canno be rejeced a any reasonable sgnfcance level: The Wald Sasc s wh a margnal sgnfcance level of In general UIP works beer beween he connenal European currences han for he oher currences. There are several aemps o explan he shor run falure of UIP (forward premum puzzle) whch wll no be dscussed here furher. For our purpose s only mporan o sress ha he Swss Franc s by no means specal wh respec o he shor run falure of UIP. I s n he long run falure of UIP, where he Swss Franc s unque. Nex le us consder he resuls of he regressons of reurn dfferenals on lagged varables represenng world-wde aggregae rsk. For he resuls shown n Table 6 we cumulaed he dfferenals over fve monh snce such large rsk evens would have effecs exendng over several monhs. The resuls are robus o varaon of he number of fuure perods (2 o 6 monhs) over whch reurns are cumulaed. Of course, he cumulaon of reurns leads o auocorrelaon whch s accouned for by usng he Newey-Wes auocorrelaon and heeroskedascy conssen coeffcen covarance esmae. Moreover, should be menoned ha he shor run varaon of he reurn dfferenals s domnaed by exchange rae componen whch has a varance many mes larger ha ha of he neres rae dfferenal. Table 6 shows a very clear paern : The economc facors are hardly sgnfcan, bu he geo-polcal dummy varables (wh he excepon of he Kuwa dummy) all have a negave and sascally and economcally hghly sgnfcan effec on fuure excess reurns. Therefore, he normal up and downs of he world economy refleced by he economc facors have hardly a sgnfcan nfluence on he Swss franc exchange rae and he reurn dfferenals. However, large and unexpeced geo-polcal evens lead o a very srong apprecaon of he Swss franc (an decrease n s) drvng down he reurn dfferenal. These fndngs are n lne wh our suggesed peso problem nerpreaon of long run negave excess reurn of Swss franc fxed ncome asses. 3

14 Table 6: Resuls of a Facor Model for Swss Franc Money Marke Excess Reurns j= 0 m, + j + s, + j + j ) = β,0 + β, l zl, +, l= ( ν OLS Esmaes of he slope coeffcens β, l wh values n parenheses, whch are based on heeroskedascy and auocorrelaon correced covarance esmae (Newey- Wes wh runcaon lag 4). Excess reurns are annualzed and n percen. z BEF CAD DEM FFR ITL JAP NLG UKP USD l, %IPIC %POIL %MSCIW %GSCIW %CGBIW Chernenko Tschernobyl Berln wall Kuwa (0.07) (.08) (-0.82) (0.30) (.83) (-5.50) -.62 (-6.33) (-.90) (-0-40) (0.83) (-050) (0.26) (0.83) (.08) (-5.2) (-4.49) (3.94) (0.004) (-030) (.8) ) (0.24) (.6) (-6.2) (-4.78) (-7.30) (0.3) (0.28) (.23) (-0.38) (0.28) (.52) (-2.74) (-6.40) (-2.45) (-0.98) (0.87) (-0.68) (.04) (2.09) (0.66) (-4.76) -.59 (-3.67) (-2.75).460 (0.9) (0.28) (-0.46) (-.3) (-.07) (2.45) (-5.2) (-.45) (-7.3) (2.29) (-0.28) 0.00 (.30) (-040) (0.2) (.90) (5.9) (-4.90) (-6.72) (-.03) ((2.22) (-0.27) (-0.04) (.07) (-0.84) (.6) (-.7) (-3.80) (-0.0) (0.64) ) (0.5) (0.33) (0.93) (-5.7) (-4.29) (-5.8) (0.02) 4

15 Fnally we urn o hsorcal evdence o deermne f he reurn dfferenal daes back longer han 30 years. Our hypohess s ha he prcng anomaly may be due o a peso effec, nvesors may be payng an nsurance premum for holdng Swss Francs because of expecaons of a rare, dscree shf n he reurn dsrbuon (for nsance caused by a war). 9 Ths suggess ha hsorcal daa from he perod before he World wars mgh be revealng o es he hypohess: If he Swss neres rae anomaly was a phenomenon of he pos-war perod only, hs would suppor he peso hypohess. We consder hsorcal neres rae dfferenals beween neres raes n Swzerland and seven major currences counres for hree perods. 0 Table 7 presens resuls from sysems of AR() equaons for seven neres rae dfferenals and hree perods. The sysem esmaes are analogous o hose for he pos-breon Woods perod repored n able 2 wh he only dfference ha reurn dfferenals can be drecly measured by he neres rae dfferenals gven fxed exchange raes. The coeffcen of neres s he nercep γ whch represens he mean reurn dfferenal afer conrollng for he AR() process (coeffcen δ). Table 7: Hsorcal Swss Franc Ineres Rae Dfferenals, Yearly daa for Gold Sandard ; Resored Gold Sandard ; Breon Woods Sysem , Resuls from AR() Models:, = γ ( δ ) + δ (, 2 2 ) + e, OLS-Esmaes, Sandard Errors n Ialcs Gold Sandard Resored Gold Sandard Breon Woods γ δ γ δ γ δ BEF (0.27) (0.3) (0.6) (0.27) (0.42) (0.27) FFR (0.25) (0.) (0.55) (0.22) (.23) (0.40) 9 See for nsance Evans (996) for a survey of he mplcaons of peso problems for asse prcng. 0 Yearly neres rae daa from was kndly provded by Mchael Bordo. We use he shor erm (3 Monh) neres raes. The bvarae VAR es was no appled o hs daa se gven he raher shor sample szes and he sascal sgnfcance of he ndvdual AR() esmaes. 5

16 DEM (0.6) (0.5) (0.6) (0.27) (0.27) (0.3) JAP (0.2) (0.6) (0.34) (0.23) (2.22) (0.20) NLG (0.26) (0.5) (0.7) (0.24) (0.46) (0.27) UKP (0.27) (0.3) (0.44) (0.2) (0.63) (0.33) USD (0.2) (0.7) (0.8) (0.43) (.25) (0.33) Noe: Perods for he ner-war gold sandard dffer, snce he suspenson daes dffer: Japan, Germany -93 UK , US -933, Belgum -935, Swzerland, Neherlands and France -936, Source: Bordo and Schwarz (994) The frs wo columns of able 6 show he resuls for he perod of he gold sandard. The nercep s negave for almos all currences, mplyng ha Swss neres raes were beween 0.4 an.2 percen hgher han n oher counres. There s only one excepon o hs rule, he Uned Saes had even hgher neres raes han Swzerland ponng o he an Emergng marke saus of he Uned Saes a he me. All nerceps are ndvdually (and jonly) sgnfcanly dfferen from zero. 2 The nex wo columns of able 6 show ha hs suaon changed afer he frs World war: Swss neres raes are lower vs-à-vs all currences wh he excepon of Japan. The dfferences are ndvdually sascally sgnfcan vs-a-vs Belgum, Germany, he UK and he US and he larges dfferenal s obaned for Germany, he counry mos affeced by war and hypernflaon. The las wo columns show ha under Breon Woods Swzerland had sgnfcanly lower neres raes han any oher major counry. All nercep erms are ndvdually sgnfcan and he dfferenals are as large as 3.5 percen n he case of he UK pound. They are smalles wh 2 The lmpng gold sandard n Belgum and France seem o have had lle effec on neres raes gven ha dfferenals were no sgnfcanly dfferen from hose of currences ha were on a pure gold sandard. The Wald es ha he nerceps for he European currences (BEL, FFR, DEN, NLG and UKP) are he same canno be rejeced a he 0 percen level. 6

17 respec o Germany and he Neherlands, a paern ha wll preval n he pos-breon Woods perod. The Wald es of he hypohess ha all reurn dfferenals are he same s rejeced wh a χ- square value of 5.76 and a margnal sgnfcance level of Ths evdence s conssen wh he hypohess ha nvesors are payng an nsurance premum on Swss Franc asses for caasrophc evens. However, he magnude of he reurn dfferenals durng nerwar perod and he Breon Woods perod have be o nerpreed wh care snce hey probably ncorporae expecaons of dsrupons and devaluaons. 3 3 By 923/25 he core counres had resored he gold sandard. Japan, Germany and UK abandoned he gold sandard n 93 a he onse of he grea depresson. The Uned Saes followed sue n 933, Belgum abandoned n 935, and Swzerland, Neherlands and France held on unl 936. Vrually all cenral banks broke he rules of he game durng hs perod by aempng o sheld he domesc economy from foregn dsurbances and offseng aempng o serlze changes n nernaonal reserves wh changes n domesc cred. Thus, he exchange rae peg dd no have he same credbly durng he perod of he resored gold sandard as had enjoyed durng he perod of he classcal gold sandard. A cavea apples o he Breon Woods perod gven he possbly of revaluaons under hs sysem. 7

18 4. Conclusons Ths paper has presened evdence of a long run anomaly n Swss asses reurns. The nomnal reurns of Swss asses has been sgnfcanly lower han n oher major currences afer correcng for exchange rae changes. Ths has been rue on average for more han 25 years mplyng unexploed arbrage gans n shorenng Swss Francs. Ths long run devaon from UIP s dfferen from he anomaly generally denfed n he leraure ha refers o he shor run anomalous response of exchange raes o changes n he neres rae dfferenal. The neres rae puzzle canno be explaned wh specfc naonal feaures of Swzerland as he Swss bankng secrecy snce s presen also n he reurns of Euromarke Swss Franc deposs locaed ousde Swzerland. We sugges ha he mos lkely explanaon for hs puzzle s a peso problem: nvesors are wllng o pay a premum for holdng Swss Frank asses expecng ha n a severe crss suaon he Swss Frank would apprecae. We fnd suppor for hs hypohess from wo emprcal fndngs: frs, we show ha he reurn dfferenal s negavely affeced n he shor run by large unexpeced geo-polcal evens. Second he examnaon of hsorcal daa on neres raes dfferenals durng he pre-war and ner-war perod show ha he abnormally low level of Swss reurns arses afer he frs world war only.. Before 94 Swzerland had hgher neres raes han mos oher counres under he gold sandard. 8

19 References: Ba, J. and Perron, P. (998), Esmang and Tesng Lnear Models wh Mulple Srucural Changes, Economerca 66, Bordo, Mchael and Anna Schwarz (997), "The Specal Sandard as a Conngen Rule: Some Evdence for Core and Perpheral Counres, " NBER Workng Paper No Bordo Mchael (993), The Breon Woods Inernaonal Moneary Sysem: A Hsorcal Overvew, n Bordo, Mchael and Barry Echengreen (eds.), A Rerospecve on he Breon Woods Sysem, Unversy of Chcago Press: Chcago and London Cochrane, John H.(999) New Facs n Fnance, NBER Workng paper no. 769, also n Economc Perspecves XXIII (3), Engel, Charles (996), The Forward Dscoun Anomaly and he Rsk Premum: a Survey of recen Evdence, Journal of Emprcal Fnance 3, Evans, Marn, D. (996), Peso Problems: Ther Theorecal and Emprcal Implcaons, n G.S. Maddala and C.R. Rao eds, Handbook of Sascs: Sascal Mehods n Fnance, Vol 4, Norh Holland Froo, Kenneh (990): Shor Run Raes and Expeced Asse Reurns, NBER Workng Paper No Hodrck, Rober (2000), Inernaonal Fnancal Managemen, Englewood Clffs, Prence Hall (NY). Joron, Phlppe and Wllam N. Goezmann (999), Global Sock Markes n he Tweneh Cenury, The Journal of Fnance, Kugler, Peer and Bearce Weder (2004), Inernaonal Porfolo Holdngs and Swss Franc Asse Reurns 2004, Swss Journal of Economcs and Sascs 3, 2 9