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Foreign Exchange Risk Premium and Policy Uncertainty

In: Encyclopedia of Finance

Author

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  • Thomas C. Chiang

    (Drexel University)

Abstract

This chapter investigates the sources of bias by using a forward foreign exchange rate as a predictor of the corresponding spot exchange rate. The forward exchange rate bias is usually perceived to be associated with a risk factor. Numerous studies, which use variables such as a forward premium, conditional variance, real interest rate differential, and equity premium differential, have attempted to explain the forward-rate bias. This chapter conducts empirical tests that add a number of news-based risk variables in four foreign exchange markets to a proposed model. Testing results suggest that the news-based exchange rate volatility, equity premium differential, economic policy uncertainty differential, and in some cases, a geopolitical risk (GPR) are key factors to explain the forward-rate bias and therefore support the risk premium hypothesis.

Suggested Citation

  • Thomas C. Chiang, 2022. "Foreign Exchange Risk Premium and Policy Uncertainty," Springer Books, in: Cheng-Few Lee & Alice C. Lee (ed.), Encyclopedia of Finance, edition 0, chapter 7, pages 585-600, Springer.
    • Handle: RePEc:spr:sprchp:978-3-030-91231-4_7
    DOI: 10.1007/978-3-030-91231-4_7
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