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Exchange Volatility and Risk Premium


  • Claudio Soto
  • Rodrigo Valdés


This paper empirically evaluates the importance of exchange rate regimes and exchange rate volatility on interest rate differentials, with special reference to Chile. We estimate risk-premia for 16 country experiences with different exchange rate regimes and then investigate whether these premia vary with volatility and the regime flexibility. When we assume that any diversifiable risk is actually traded and estimate a CAPM model augmented by taxes, we find a systematic but small relation between exchange rate volatility and risk-premium. In the case of Chile we do not find any significant impact of changes in exchange rate volatility on CAPM-estimated risk-premium. However, when we consider the overall effect of volatility on risk-premium and estimate an ARCH-M model we find a large effect of volatility on risk-premium in this country. In this set-up, when we analyze the cross-country experience, we do not find any relation between regime flexibility and risk-premium.

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  • Claudio Soto & Rodrigo Valdés, 1999. "Exchange Volatility and Risk Premium," Working Papers Central Bank of Chile 46, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:46

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    1. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "Empirical research on nominal exchange rates," Handbook of International Economics,in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 33, pages 1689-1729 Elsevier.
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