Macroeconomic Sources of Foreign Exchange Risk in New EU Members

Tigran Poghosyan and Evzen Kocenda ()

No wp898, William Davidson Institute Working Papers Series from William Davidson Institute at the University of Michigan Stephen M. Ross Business School

Abstract: We address the issue of foreign exchange risk and its macroeconomic determinants in several new EU members. The joint distribution of excess returns in the foreign exchange market and the observable macroeconomic factors is modeled using the stochastic discount factor (SDF) approach and a multivariate GARCH-in-mean model. We find that in post-transition economies real factors play a small role in determining foreign exchange risk, while nominal and monetary factors have a significant impact. Therefore, to contribute to the further stability of their domestic currencies, the central banks in the new EU member countries should continue stabilization policies aimed at achieving nominal convergence with the core EU members, as nominal factors play a crucial role in explaining the variability of the risk premium.

Keywords: foreign exchange risk; time-varying risk premium; stochastic discount factor; multivariate GARCH-in-mean; post-transition and emerging markets (search for similar items in EconPapers)
JEL-codes: C22 F31 G15 P59 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-eec, nep-ifn, nep-mac, nep-rmg and nep-tra
Date: 2007-11-01

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Persistent link: http://EconPapers.repec.org/RePEc:wdi:papers:2007-898

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