Properties of Foreign Exchange Risk Premiums

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Properties of Foreign Exchange Risk Premiums

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Title: Properties of Foreign Exchange Risk Premiums
Author: Sarno, Lucio; Schneider, Poul; Wagner, Christian
Abstract: We study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, de¯ned as the tendency of high-interest rate currencies to ap- preciate rather than depreciate. These risk premiums arise endogenously from the no-arbitrage condition relating the term structure of interest rates and exchange rates. Estimating a±ne (multi-currency) term structure models reveals a noticeable tradeo® between matching depreciation rates and accuracy in pricing bonds. Risk premiums implied by our global a±ne model generate unbiased predictions for cur- rency excess returns and are closely related to global risk aversion, the business cycle, and traditional exchange rate fundamentals.
URI: http://hdl.handle.net/10398/9098
Date: 2015-01-26
Notes: NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Financial Economics. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Financial Economics, VOL105, ISSUE2, August 2012. DOI:10.1016/j.jfineco.2012.01.005

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