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Foreign Exchange Risk Premium Determinants: Case of Armenia

  • Tigran Poghosyan
  • Evzen Kocenda

This paper studies foreign exchange risk premium using the uncovered interest rate parity framework in a model economy. The analysis is performed using weekly data on foreign and domestic currency deposits in the Armenian banking system. Results of the study indicate that contrary to the established view there is a positive correspondence between exchange rate depreciation and interest rate differentials. Further, it is shown that a systematic positive risk premium required by economic agents for foreign exchange transactions increases over the investment horizon. One-factor two-currency affine term structure framework applied in the paper is not sufficient to explain the driving forces behind the positive exchange rate risk premium. GARCH approach shows that central bank interventions and deposit volumes are two factors explaining time-varying exchange rate risk premium.

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Paper provided by The Center for Economic Research and Graduate Education - Economics Institute, Prague in its series CERGE-EI Working Papers with number wp297.

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Date of creation: May 2006
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Handle: RePEc:cer:papers:wp297
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