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The risk premium and the liquidity premium in foreign exchange markets

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  • Charles Engel

Abstract

The forward exchange rate may include a liquidity premium as well as a risk premium. The nature of these premiums is investigated in a general equilibrium model. The more obvious point the paper makes is that the forward rate will be affected by the liquidity of financial assets. The subtle point the paper makes is that the liquidity premium of the forward rate is also influenced by the liquidity of goods. Copyright 1992 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
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Suggested Citation

  • Charles Engel, 1990. "The risk premium and the liquidity premium in foreign exchange markets," Research Working Paper 90-07, Federal Reserve Bank of Kansas City.
  • Handle: RePEc:fip:fedkrw:90-07
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    Cited by:

    1. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk under currency boards," Journal of Development Economics, Elsevier, vol. 69(2), pages 367-391, December.
    2. 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.
    3. Juan-Ángel Jiménez-Martín & Rafael Flores de Frutos, 2004. "The Fit of Dynamic Equilibrium Models of Exchange Rate," Documentos de Trabajo del ICAE 0411, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    4. Karen K. Lewis, 1994. "Puzzles in International Financial Markets," NBER Working Papers 4951, National Bureau of Economic Research, Inc.
    5. Prakash Apte & Piet Sercu & Raman Uppal, 1996. "The Equilibrium Approach to Exchange Rates: Theory and Tests," NBER Working Papers 5748, National Bureau of Economic Research, Inc.
    6. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk : facts and puzzles from currency boards," Policy Research Working Paper Series 2815, The World Bank.
    7. Kevin X.D. Huang & Thaneepanichskul Suchada, 2003. "Sources of Exchange Rate Fluctuations: The Cases of Mexico and Thailand in the Aftermaths of their Recent Currency Crises," Annals of Economics and Finance, Society for AEF, vol. 4(2), pages 375-400, November.

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    Keywords

    Foreign exchange ; Risk;

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