The Foreign Exchange Risk Premium in a Target Zone with Devaluation Risk

Lars Svensson

No 494, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The foreign exchange risk premium in an exchange rate target-zone regime with devaluation/realignment risks is derived. In contrast to previous literature, the exchange rate's heteroscedasticity within the band, as well as a separate devaluation/realignment risk, is taken into account. The risk premium is then the sum of two separate risk premia, arising from stochastic exchange rate movements within the band and from stochastic devaluations/realignments when the bank is shifted. Both real and nominal exchange rate premia are considered. The real and nominal risk premia from movements within the band are very small for narrow target zones and can therefore be disregarded. The real and nominal risk premia from devaluations/realignments are larger but still relatively small proportions of the expected rate of devaluation/realignment.

Keywords: Devaluation; Exchange Rates; Foreign Exchange; Realignment; Risk Premia; Target Zones (search for similar items in EconPapers)
Date: 1991-01
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Related works:
Journal Article: The foreign exchange risk premium in a target zone with devaluation risk (1992)
Working Paper: The Foreign Exchange Risk Premium in a Target Zone with Devaluation Risk (1990)
Working Paper: The Foreign Exchange Risk Premium in a Target Zone with Devaluation Risk (1990)
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