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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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References

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  1. Geert Bekaert & Robert J. Hodrick & David A. Marshall, 1994. "The Implications of First-Order Risk Aversion for Asset Market Risk Premiums," NBER Working Papers 4624, National Bureau of Economic Research, Inc.
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  3. Obstfeld, Maurice & Rogoff, Kenneth S., 1995. "Exchange Rate Dynamics Redux," Scholarly Articles 12491026, Harvard University Department of Economics.
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  6. Viceira, Luis & Campbell, John, 2001. "Who Should Buy Long-Term Bonds?," Scholarly Articles 3128709, Harvard University Department of Economics.
  7. David Backus & Silverio Foresi & Chris Telmer, 1996. "Affine Models of Currency Pricing," New York University, Leonard N. Stern School Finance Department Working Paper Seires, New York University, Leonard N. Stern School of Business- 96-9, New York University, Leonard N. Stern School of Business-.
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Citations

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Cited by:
  1. Adrien Verdelhan, 2010. "A Habit-Based Explanation of the Exchange Rate Risk Premium," Journal of Finance, American Finance Association, American Finance Association, vol. 65(1), pages 123-146, 02.
  2. 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, Boston University - Department of Economics WP2006-040, Boston University - Department of Economics.
  3. Kocenda, Evzen & Poghosyan, Tigran, 2009. "Macroeconomic sources of foreign exchange risk in new EU members," Journal of Banking & Finance, Elsevier, vol. 33(11), pages 2164-2173, November.
  4. Katrin Rabitsch, 2014. "An Incomplete Markets Explanation to the UIP Puzzle," Department of Economics Working Papers wuwp171, Vienna University of Economics, Department of Economics.
  5. 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.
  6. Lothian, James R. & Wu, Liuren, 2011. "Uncovered interest-rate parity over the past two centuries," Journal of International Money and Finance, Elsevier, Elsevier, vol. 30(3), pages 448-473, April.
  7. Lustig, Hanno & Roussanov, Nikolai & Verdelhan, Adrien, 2014. "Countercyclical currency risk premia," Journal of Financial Economics, Elsevier, Elsevier, vol. 111(3), pages 527-553.
  8. 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.
  9. Lustig, H. & Verdelhan, A., 2006. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," Working papers, Banque de France 155, Banque de France.
  10. repec:yor:yorken:01/13 is not listed on IDEAS
  11. Iwata, Shigeru & Wu, Shu, 2009. "Stock market liberalization and international risk sharing," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 19(3), pages 461-476, July.
  12. Shu Wu, 2007. "Interest Rate Risk and the Forward Premium Anomaly in Foreign Exchange Markets," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 39(2-3), pages 423-442, 03.

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