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State-Uncertainty preferences and the Risk Premium in the Exchange rate market

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Abstract

This paper introduces state-uncertainty preferences into the Lucas (1982) economy, showing that this type of preferences helps to explain the exchange rate risk premium. Under these preferences we can distinguish between two factors driving the exchange rate risk premium: “macroeconomic risk” and “the risk associated with variation in the private agents’ perception on the level of uncertainty”. State-uncertainty preferences amount to assuming that a given level of consumption will yield a higher level of utility the lower is the level of uncertainty perceived by consumers. Furthermore, empirical evidence from three main European economies in the transition period to the euro provides empirical support for the model

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Paper provided by Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico in its series Documentos de Trabajo del ICAE with number 0917.

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Length: 25 pages
Date of creation: 2009
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Handle: RePEc:ucm:doicae:0917

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Keywords: Risk premium; taste shocks; fundamental uncertainty.;

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Cited by:
  1. Al-Shboul, Mohammad & Anwar, Sajid, 2014. "Time-varying exchange rate exposure and exchange rate risk pricing in the Canadian Equity Market," Economic Modelling, Elsevier, vol. 37(C), pages 451-463.

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