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Market Instability and Revision Error in Risk Premium

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  • Heeho Kim

Abstract

This paper provides a theory and evidence that the risk premium puzzle is viewed as a phenomenon pertaining to the unstable foreign exchange market. In an unstable market, revision error uncompensated by an initial risk premium accrues due to consumer expectation revision about the ex ante uncertainty of the exchange rate. The risk premium widely deviates from its initial level, depending on the frequency of the consumer expectation revision and the degree of risk aversion. Subsequent evidence shows the existence of the revision errors for the risk premium during the Asian currency crisis and the recent financial crisis periods. Copyright International Atlantic Economic Society 2011

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  • Heeho Kim, 2011. "Market Instability and Revision Error in Risk Premium," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 17(2), pages 169-180, May.
    • Handle: RePEc:kap:iaecre:v:17:y:2011:i:2:p:169-180:10.1007/s11294-011-9299-y
    DOI: 10.1007/s11294-011-9299-y
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    More about this item

    Keywords

    Revision error; Risk aversion; Premium puzzle; Forward premium anomaly; F31; G15;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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