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Foreign Exchange Risk Premium Determinants: Case of Armenia

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Author Info
Tigran Poghosyan
Evzen Kocenda

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Abstract

This paper studies foreign exchange risk premium using the uncovered interest rate parity framework in a model economy. The analysis is performed using weekly data on foreign and domestic currency deposits in the Armenian banking system. Results of the study indicate that contrary to the established view there is a positive correspondence between exchange rate depreciation and interest rate differentials. Further, it is shown that a systematic positive risk premium required by economic agents for foreign exchange transactions increases over the investment horizon. One-factor two-currency affine term structure framework applied in the paper is not sufficient to explain the driving forces behind the positive exchange rate risk premium. GARCH approach shows that central bank interventions and deposit volumes are two factors explaining time-varying exchange rate risk premium.

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Paper provided by The Center for Economic Research and Graduate Education - Economic Institute, Prague in its series CERGE-EI Working Papers with number wp297.

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Date of creation: May 2006
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Handle: RePEc:cer:papers:wp297

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Related research
Keywords: “Forward premium” puzzle exchange rate risk time-varying risk premium affine term structure models GARCH-in-Mean foreign and domestic deposits transition and emerging markets Armenia.

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Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F31 - International Economics - - International Finance - - - Foreign Exchange
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment
P20 - Economic Systems - - Socialist Systems and Transition Economies - - - General

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