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Modeling Foreign Exchange Risk Premium in Armenia

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Author Info

  • Tigran Poghosyan
  • Evžen Kočenda
  • Petr Zemčik

Abstract

This paper applies stochastic discount factor methodology to modeling the foreign exchange risk premium in Armenia. We use weekly data on foreign and domestic currency deposits, which coexist in the Armenian banking system. This coexistence implies elimination of the cross-country risks and transaction costs, leaving the pure foreign exchange risk. It is shown that there exists a systematic time-varying risk premium that increases with maturity. Using two-currency affine term structure and generalized autoregressive conditional heteroskedasticity (GARCH)-in-mean models, we find that the central bank's foreign exchange market interventions and ratio-of-deposit volumes significantly affect public expectations about foreign exchange fluctuations. We also find that the foreign exchange risk premium accounts for the largest part of the interest differential. When accounting for economic and institutional differences, our results can be extended to other countries.

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Bibliographic Info

Article provided by M.E. Sharpe, Inc. in its journal Emerging Markets Finance and Trade.

Volume (Year): 44 (2008)
Issue (Month): 1 (January)
Pages: 41-61

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Handle: RePEc:mes:emfitr:v:44:y:2008:i:1:p:41-61

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Web page: http://mesharpe.metapress.com/link.asp?target=journal&id=111024

Related research

Keywords: affine term structure models; Armenia; foreign exchange risk; forward premium puzzle; GARCH-in-mean; time-varying risk premium; transition and emerging markets;

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Cited by:
  1. Uluc Aysun & Sanglim Lee, 2013. "The determinants of the deviations from the interest rate parity condition," Working Papers 2013-03, University of Central Florida, Department of Economics.
  2. Andres Felipe García-Suaza & José E. Gómez González, 2011. "A simple test of momentum in foreign exchange markets," DOCUMENTOS DE TRABAJO 008170, UNIVERSIDAD DEL ROSARIO.
  3. Kim, Heeho, 2011. "The risk adjusted uncovered equity parity," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1491-1505.
  4. Li, Dandan & Ghoshray, A. & Morley, B., 2011. "Uncovered Interest Parity and the Risk Premium," Department of Economics Working Papers 24072, University of Bath, Department of Economics.
  5. Carmen Gloria Silva, 2010. "Forward premium puzzle and term structure of interest rates: the case of New Zealand," Working Papers Central Bank of Chile 570, Central Bank of Chile.

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