State-Uncertainty preferences and the Risk Premium in the Exchange rate market

Juan Jimenez-Martin and Alfonso Novales

No 2009-17, Documentos de Trabajo del ICAE from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico

Abstract: This paper introduces state-uncertainty preferences into the Lucas (1982) economy, showing that this type of preferences helps to explain the exchange rate risk premium. Under these preferences we can distinguish between two factors driving the exchange rate risk premium: “macroeconomic risk” and “the risk associated with variation in the private agents’ perception on the level of uncertainty”. State-uncertainty preferences amount to assuming that a given level of consumption will yield a higher level of utility the lower is the level of uncertainty perceived by consumers. Furthermore, empirical evidence from three main European economies in the transition period to the euro provides empirical support for the model

Keywords: Risk premium; Taste shocks; Fundamental uncertainty. (search for similar items in EconPapers)
JEL-codes: F31 F41 G12 G15 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2009
New Economics Papers: this item is included in nep-ifn and nep-upt
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Journal Article: State-uncertainty preferences and the risk premium in the exchange rate market (2010)
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