The Present-Value Model of the Exchange Rate with a Persistently Time-Varying Risk Premium: Evidence from the Dollar-Yen Rate

Makoto Shimizu

Open Economies Review, 2020, vol. 31, issue 5, No 4, 1037-1059

Abstract: Abstract In this study, I formulate a present value model of the exchange rate with a risk premium and introduce exchange rate risk exposure as a factor of the persistently time-varying risk premium. The present value model incorporates expectations for the distant future, and therefore, indicates that spot exchange rate variations reflect changes in long-run future interest rate differential and exchange rate expectations, in addition to a risk premium for long-run risk exposure. I also conduct empirical analyses using mainly the USD/JPY rate and other exchange rates against the USD. The Japanese current account balance provides a better estimation of the change in USD/JPY rate market risk exposure as USD invoiced trades are prevalent in Japan. Then, I demonstrate the possibility that a persistently time-varying risk premium offsets the effect of the interest rate differential on exchange rate variations, which can be a solution to the uncovered interest rate parity puzzle.

Keywords: Exchange rate; Time-varying risk premium; Uncovered interest rate parity; Current account balance; Invoiced currency; F3; F37; F4; G15 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://link.springer.com/10.1007/s11079-020-09582-7 Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:openec:v:31:y:2020:i:5:d:10.1007_s11079-020-09582-7

Ordering information: This journal article can be ordered from
http://www.springer. ... cs/journal/11079/PS2

DOI: 10.1007/s11079-020-09582-7

Access Statistics for this article

Open Economies Review is currently edited by G.S. Tavlas

More articles in Open Economies Review from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().