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The risk premium in the foreign exchange market

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  • Anne C. Sibert

Abstract

This paper presents a dynamic, optimizing model of the risk premium in the forward foreign exchange market. Agents face random endowments and money growth rates. Complete insurance markets do not exist and foreign exchange is held to hedge against risk. In some examples with log-linear preferences, the size of the risk premium in the forward market is related to the variability of output and money growth. An interesting conclusion of the model is that for plausible examples, the convexity component of the nominal risk premium (due to Siegel's paradox) may be quite large relative to the total risk premium. Copyright 1989 by Ohio State University Press.
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Suggested Citation

  • Anne C. Sibert, 1987. "The risk premium in the foreign exchange market," Research Working Paper 87-07, Federal Reserve Bank of Kansas City.
    • Handle: RePEc:fip:fedkrw:87-07
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    Cited by:

    1. Choudhry, Taufiq, 1999. "Re-examining forward market efficiency Evidence from fractional and Harris-Inder cointegration tests," International Review of Economics & Finance, Elsevier, vol. 8(4), pages 433-453, November.
    2. Edlin, Aaron S., 2002. "Forward Discount Bias, Nalebuff's Envelope Puzzle, and the Siegel Paradox in Foreign Exchange," Berkeley Olin Program in Law & Economics, Working Paper Series qt2wc1p9pw, Berkeley Olin Program in Law & Economics.
    3. Kam Chu, 2005. "Solution to the Siegel Paradox," Open Economies Review, Springer, vol. 16(4), pages 399-405, October.
    4. Edlin Aaron S., 2002. "Forward Discount Bias, Nalebuff's Envelope Puzzle, and the Siegel Paradox in Foreign Exchange," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 2(1), pages 1-11, September.
    5. Battermann, Harald L & Broll, Udo, 2001. "Inflation Risk, Hedging, and Exports," Review of Development Economics, Wiley Blackwell, vol. 5(3), pages 355-362, October.
    6. Georges Prat & Remzi Uctum, 2008. "The dynamics of ex-ante risk premia in the foreign exchange market: Evidence from the yen/usd exchange rate Using survey data," Working Papers hal-04140761, HAL.
    7. Rankin, Neil, 1998. "Nominal rigidity and monetary uncertainty in a small open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 22(5), pages 679-702, May.
    8. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    9. Bernard Dumas, 1993. "Partial- vs general-equilibrium models of the international capital market," Working Papers hal-00610766, HAL.
    10. Sonia Pangusión Espinosa., "undated". "Testing Uncovered Interest Rate Parity: The Spanish case," Studies on the Spanish Economy 128, FEDEA.
    11. Sibert, Anne, 1996. "Unconventional preferences: do they explain foreign exchange risk premia?," Journal of International Money and Finance, Elsevier, vol. 15(1), pages 149-165, February.
    12. Svensson, Lars E. O., 1992. "The foreign exchange risk premium in a target zone with devaluation risk," Journal of International Economics, Elsevier, vol. 33(1-2), pages 21-40, August.
    13. Leduc, Sylvain, 2002. "Incomplete markets, borrowing constraints, and the foreign exchange risk premium," Journal of International Money and Finance, Elsevier, vol. 21(7), pages 957-980, December.
    14. Bekaert, Geert & Hodrick, Robert J., 1993. "On biases in the measurement of foreign exchange risk premiums," Journal of International Money and Finance, Elsevier, vol. 12(2), pages 115-138, April.

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    Keywords

    Foreign exchange; Foreign exchange futures;

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