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Exchange Rate Risk and Deviations from Purchasing Power Parity

Michael Arghyrou (), Wenna Lu and Panayiotis Pourpourides ()

No E2020/5, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: Firstly, we show that domestic prices of net importer countries incorporate a risk premium, driven by higher moments of future nominal exchange rate returns and secondly, using US dollar exchange rates against three currencies of major net exporting countries to the US such as Canada, Japan and the European Union, we find that the skewness of the future nominal exchange rate is the major and statistically robust moment-based factor of the deviations from purchasing power parity (PPP). Our estimates further suggest that only low and moderate exchange rate risks induce risk premia that drive deviations from PPP.

Keywords: Purchasing Power Parity; risk-aversion; exchange rate; downside risk (search for similar items in EconPapers)
JEL-codes: F31 F41 G15 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2020-05
New Economics Papers: this item is included in nep-mon, nep-opm and nep-ore
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