Long-term foreign exchange risk premia and inflation risk

Daehwan Kim and Fabio Moneta

International Review of Financial Analysis, 2021, vol. 78, issue C

Abstract: As highlighted by recent literature, long-term foreign exchange risk premia (FRP) of a currency pair tend to covary negatively with short-term real interest rate differentials (RIRD) of the pair. We fit an affine term structure model for 9 major currencies against the US dollar and estimate two components of this covariance: the real risk premia (RRP) component and the inflation risk premia differential (IRPD) component. We find that the IRPD component is significantly negative for all currency pairs in our sample. We propose a macro-finance model to understand the types of shocks that generate such covariance.

Keywords: Foreign exchange risk premia; Real interest rates; Inflation risk; Affine term structure model; Inflation volatility (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:78:y:2021:i:c:s1057521921002271

DOI: 10.1016/j.irfa.2021.101901

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