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Macroeconomic Shocks And The Foreign Exchange Risk Premia

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  • IWATA, SHIGERU
  • WU, SHU

Abstract

In this paper we empirically examine the sources of the volatility of the foreign exchange risk premia. Using a nonlinear structural Vector Autoregression (VAR) model based on no-arbitrage condition to identify various macroeconomic shocks and the foreign exchange risk premia, we find that more than 80% of the volatilities of the currency risk premia can be accounted for by the standard macroeconomic shocks that drive output and inflation. By explicitly modelling the currency risk premia in the VAR system, we also offer a potential reconciliation for the seemingly contradicting observations from the previous VAR analysis of the exchange rate “overshooting” behavior under exogenous monetary innovations.

Suggested Citation

  • Iwata, Shigeru & Wu, Shu, 2006. "Macroeconomic Shocks And The Foreign Exchange Risk Premia," Macroeconomic Dynamics, Cambridge University Press, vol. 10(4), pages 439-466, September.
    • Handle: RePEc:cup:macdyn:v:10:y:2006:i:04:p:439-466_06
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    Cited by:

    1. Evžen Koèenda & Tigran Poghosyan, 2010. "Exchange Rate Risk in Central European Countries," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 60(1), pages 22-39, February.
    2. da Costa, Carlos E. & Issler, João V. & Matos, Paulo F., 2015. "A Note On The Forward And The Equity Premium Puzzles: Two Symptoms Of The Same Illness?," Macroeconomic Dynamics, Cambridge University Press, vol. 19(2), pages 446-464, March.
    3. Kodongo, Odongo & Ojah, Kalu, 2014. "The conditional pricing of currency and inflation risks in Africa's equity markets," MPRA Paper 56100, University Library of Munich, Germany.
    4. Bernard Walley, 2015. "Macroeconomic sources of foreign exchange risk premium: evidence from South Africa," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 39(2), pages 382-395, April.

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