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The Forward Premium Puzzle And Risk Premiums

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  • Nagayasu, Jun

Abstract

This paper re-evaluates the forward premium puzzle using the Euro/US dollar exchange rate. Unlike previous studies, a state-space model is used to measure the significance of this puzzle by estimating the time-specific parameter. Then we provide evidence that the forward premium puzzle became more prominent around the time of the Lehman Shock, and this additional effect of the puzzle is more clearly seen in longer maturity assets. Furthermore, while the risk premium does not tell the whole story about the time-varying puzzle, we show nevertheless that the puzzle can be lessened by this extra factor particularly at times of financial crises.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 42472.

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Date of creation: 01 Sep 2012
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Handle: RePEc:pra:mprapa:42472

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Keywords: forward premium puzzle; risk premium; time-varying parameters; financial crises;

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  1. Frankel, Jeffrey & Poonawala, Jumana, 2010. "The forward market in emerging currencies: Less biased than in major currencies," Journal of International Money and Finance, Elsevier, Elsevier, vol. 29(3), pages 585-598, April.
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  5. Hanno Lustig & Adrien Verdelhan, 2006. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," Boston University - Department of Economics - Working Papers Series, Boston University - Department of Economics WP2006-045, Boston University - Department of Economics.
  6. Stephen Hall & P. A. V. B. Swamy & George S. Tavlas & Amangeldi Kenjegaliev, 2011. "The Forward Rate Premium Puzzle: A Resolution?," Discussion Papers in Economics, Department of Economics, University of Leicester 11/23, Department of Economics, University of Leicester.
  7. Byrne, Joseph P & Nagayasu, Jun, 2011. "Common factors of the exchange risk premium in emerging European markets," MPRA Paper 31393, University Library of Munich, Germany.
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  15. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, Econometric Society, vol. 55(2), pages 391-407, March.
  16. Jun Nagayasu, 2011. "The Common Component in Forward Premiums: Evidence from the Asia–Pacific Region," Review of International Economics, Wiley Blackwell, Wiley Blackwell, vol. 19(4), pages 750-762, 09.
  17. Tigran Poghosyan & Evzen Kocenda, 2007. "Macroeconomic Sources of Foreign Exchange Risk in New EU Members," William Davidson Institute Working Papers Series, William Davidson Institute at the University of Michigan wp898, William Davidson Institute at the University of Michigan.
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