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Are Risk Premia Related to Real Exchange Rate Swings? Survey Expectations and I(2) Trends

Author

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  • Josh Stillwagon

    () (Department of Economics, Trinity College)

Abstract

This paper finds strong evidence of a positive relationship between currency risk premia and real exchange rate swings, significant at the 1% if not 0.1% level, for three USD exchange rate samples. The risk premia are measured using survey data on traders' exchange rate forecasts. This circumvents the need for an auxiliary hypothesis of rationality and enables more direct focus on risk behavior. The analysis is conducted using the I(2) cointegrated VAR which allows for time-varying trends in the variables. Evidence of persistent changes is found for interest rates, prices, and nominal and real exchange rates. Interest rate shocks appear to drive the system, while expectations are correcting only in the longer-run.

Suggested Citation

  • Josh Stillwagon, 2013. "Are Risk Premia Related to Real Exchange Rate Swings? Survey Expectations and I(2) Trends," Working Papers 1318, Trinity College, Department of Economics.
  • Handle: RePEc:tri:wpaper:1318
    as

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    File URL: http://internet2.trincoll.edu/repec/WorkingPapers2013/WP13-18.pdf
    File Function: First version, 2013
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Time-varying risk premium; survey data; polynomial cointegration; real exchange rate swings; imperfect knowledge;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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