Determinants of Currency Risk Premiums

Carlson, J.A: Osler, C.L.

Working Papers from Purdue University, Krannert School of Management - Center for International Business Education and Research (CIBER)

Abstract: The risk premium is a function of both the interest rate differential and the gap between the current exchange rate and its long-run equilibrium in a model of the foreign exchange market with both non-speculating traders and rational speculators. If the speculators have an alternative to specializing in exchange-rate speculation, then there should be no presumption that uncovered interest rate parity will hold even approximately with a long-run equilibrium number of speculators. Furthermore, when other traders respond to interest-rate differentials, the model can give rise to a negative relationship between the interest-rate differential and the subsequent change in the exchange rate, a phenomenon that is often evident in foreign exchange markets.

Keywords: INTERNATIONAL FINANCIAL MARKET; CURRENCIES; EXCHANGE RATE (search for similar items in EconPapers)
JEL-codes: F30 F31 E42 (search for similar items in EconPapers)
Date: 1998

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Persistent link: http://EconPapers.repec.org/RePEc:fth:purkib:98-006

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