Abstract
This paper applies a recent method proposed by Maggiori (The U.S. Dollar Safety Premium, 2013) to estimate the Swiss franc safety premium. The results show that the three-step instrumental variable approach as used by Maggiori does not work for the Swiss franc exchange rates. The price of risk estimates take unrealistic, negative values. One possible explanation is that the approach as it is used by Maggiori suffers from a measurement error for the expected exchange rate which represents a potential source of imprecision. By using the prediction of an augmented Fama regression to measure the expected exchange rate change, this measurement error can be avoided and the safety premium estimates become more realistic and closer to those obtained with a maximum likelihood-estimated GARCH approach. Overall, however, the GARCH approach still seems to be preferable to the instrumental variable approach.
Highlights
The recent financial crisis and the subsequent European sovereign debt crisis provoked a large flight to quality among investors and caused strong upward pressure on the Swiss franc (CHF)
Once a potential structural break in the relationship between Swiss franc exchange rate returns and equity returns in early 1999 is taken into account, these results reveal that the CHF safety premium is timevarying, highest in times of crisis, and was equal to around 4.5% with peaks of up to 12.5% during the recent financial crisis, supporting the view of the CHF acting as a safe haven during periods of high risk
The results on the exchange rate models are in line with the literature and confirm the common finding of the failure of UIP: Uncovered interest parity predicts a coefficient of −1 on the interest differential, while in the data one usually finds insignificant or even positive values12
Summary
The recent financial crisis and the subsequent European sovereign debt crisis provoked a large flight to quality among investors and caused strong upward pressure on the Swiss franc (CHF). The safety premium for the Swiss franc reflected in the EUR/CHF exchange rate during the recent financial crisis would be around 1% to maximally 3.5% (on an annual basis)17, a value that seems to be rather low in the light of the dramatic appreciations it experienced at the time and that might be attributed to the poor performance of the instruments.
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