Risk and return in the foreign exchange market: Measurement without VARs

Shaowen Luo

International Finance, 2023, vol. 26, issue 1, 64-81

Abstract: This paper offers a detailed investigation of the foreign‐exchange risk premium using a structural relationship in the inflation‐index bond market, first introduced by Clarida. Unlike the conventional vector autoregressive (VAR) approach, this approach estimates risk premium through the non‐arbitrage relationship between investing in inflation‐indexed bonds from two countries and works in the market information set. A rise in the estimated foreign‐currency risk premium helps to forecast dollar depreciation in subsequent periods. And the forecasting power is stronger than that of the other existing VAR approaches.

Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:bla:intfin:v:26:y:2023:i:1:p:64-81

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