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The Foreign Exchange Risk Premium: Real and Nominal Factors

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  • Hollifield, Burton

    (Carnegie Mellon U)

  • Yaron, Amir

    (U of Pennsylvania)

Abstract

We estimate the effects of conditional inflation moments on predictable returns available from currency speculation using an arbitrage based model to decompose the risk premium into conditional inflation, real risk, and their interactions. Using two different empirical methods to identify these components, we find that virtually none of the predictable variation in returns from currency speculation can be explained empirically by either conditional inflation risk or the interaction between conditional inflation and real risks. Our results imply that for monetary policy to have significant effects on the risk-premia for currency speculation, monetary policy must have small effect on inflation risk, the relationship between real risk and inflation risk, and instead must mainly impact real exchange rate risk.

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Bibliographic Info

Paper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 01-1.

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Date of creation: Feb 2001
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Handle: RePEc:ecl:upafin:01-1

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  1. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
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Citations

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Cited by:
  1. Tigran Poghosyan & Evzen Kocenda, 2007. "Macroeconomic Sources of Foreign Exchange Risk in New EU Members," William Davidson Institute Working Papers Series wp898, William Davidson Institute at the University of Michigan.
  2. Adrien Verdelhan & Hanno Lustig, 2005. "The Cross-Section Of Foreign Currency Risk Premia And Consumption Growth Risk," Boston University - Department of Economics - Working Papers Series WP2005-019, Boston University - Department of Economics.
  3. Lothian, James R. & Wu, Liuren, 2011. "Uncovered interest-rate parity over the past two centuries," Journal of International Money and Finance, Elsevier, vol. 30(3), pages 448-473, April.
  4. Adrien Verdelhan, 2006. "A Habit-Based Explanation of the Exchange Rate Risk Premium," Boston University - Department of Economics - Working Papers Series WP2006-047, Boston University - Department of Economics.
  5. Shu Wu, 2007. "Interest Rate Risk and the Forward Premium Anomaly in Foreign Exchange Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 423-442, 03.
  6. Hanno Lustig & Adrien Verdelhan, 2005. "The Cross-Section of Currency Risk Premia and US Consumption Growth Risk," NBER Working Papers 11104, National Bureau of Economic Research, Inc.
  7. Hanno Lustig & Nikolai Roussanov & Adrien Verdelhan, 2010. "Countercyclical Currency Risk Premia," NBER Working Papers 16427, National Bureau of Economic Research, Inc.
  8. Doriana Ruffino & Jonathan Treussard, 2006. "A Study of Inaction in Investment Games via the Early Exercise Premium Representation," Boston University - Department of Economics - Working Papers Series WP2006-040, Boston University - Department of Economics.
  9. Katrin Rabitsch, 2014. "An Incomplete Markets Explanation to the UIP Puzzle," Department of Economics Working Papers wuwp171, Vienna University of Economics, Department of Economics.
  10. Mike R Wickens & Peter N Smith, . "Macroeconmic Sources of FOREX Risk," Discussion Papers 01/13, Department of Economics, University of York.
  11. Hanno Lustig, 2004. "The Cross-Section of Foreign Currency Risk Premia and US Consumption Growth Risk (joint with Adrien Verdelhan)(updated February 2006)," UCLA Economics Online Papers 303, UCLA Department of Economics.
  12. Iwata, Shigeru & Wu, Shu, 2009. "Stock market liberalization and international risk sharing," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 19(3), pages 461-476, July.

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