Real and Monetary Shocks and Risk Premia in Forward Markets for Foreign Exchange

John Dutton

Journal of Money, Credit and Banking, 1993, vol. 25, issue 4, 731-54

Abstract: A version of the model of Lucas (1982) and Domowitz and Hakkio (1985) is used to compute risk premia on forward foreign exchange from stochastic shocks to goods and money. Risk premium signs and magnitudes vary with shocks and with the intratemporal substitutability of goods in consumption. When the elasticity of substitution is less than (greater than) one, an increase in home good variance induces a decrease (increase) in the risk premium on forward foreign currency. When money is the source of shock, no risk premia appear. A premium can appear unrelated to risk but caused by a 'Jensen's inequality effect.' Copyright 1993 by Ohio State University Press.

Date: 1993
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