Where’s the Risk? The Forward Premium Bias, the Carry-Trade Premium, and Risk-Reversals in General Equilibrium

Kimberly Berg and Nelson Mark

Journal of International Money and Finance, 2019, vol. 95, issue C, 297-316

Abstract: This paper builds a two-country dynamic stochastic general equilibrium macro model to understand three empirical facts about international currency returns. They are the downward forward premium bias, the carry trade return, and the long-run risk reversal. Cross-country heterogeneity in unit-root productivity levels generates the systematic risk priced into currency returns. The risk can be magnified through monetary policy. Both a complete markets and an incomplete markets model are qualitatively consistent with these facts. Quantitatively, the incomplete markets model performs better.

Keywords: Currency risk; DSGE; Monetary policy (search for similar items in EconPapers)
JEL-codes: E21 E43 F31 G12 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:95:y:2019:i:c:p:297-316

DOI: 10.1016/j.jimonfin.2018.03.011

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