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The Foreign Exchange Risk Premium: Real and Nominal Factors

  • Hollifield, Burton

    (Carnegie Mellon U)

  • Yaron, Amir

    (U of Pennsylvania)

We estimate the effects of conditional inflation moments on predictable returns available from currency speculation using an arbitrage based model to decompose the risk premium into conditional inflation, real risk, and their interactions. Using two different empirical methods to identify these components, we find that virtually none of the predictable variation in returns from currency speculation can be explained empirically by either conditional inflation risk or the interaction between conditional inflation and real risks. Our results imply that for monetary policy to have significant effects on the risk-premia for currency speculation, monetary policy must have small effect on inflation risk, the relationship between real risk and inflation risk, and instead must mainly impact real exchange rate risk.

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Paper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 01-1.

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Date of creation: Feb 2001
Date of revision:
Handle: RePEc:ecl:upafin:01-1
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  8. Viceira, Luis & Campbell, John, 2001. "Who Should Buy Long-Term Bonds?," Scholarly Articles 3128709, Harvard University Department of Economics.
  9. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  10. Charles Engel, 1995. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
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  17. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
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