Determinants of current risk premiums

John Carlson and Carol Osler

No 70, Staff Reports from Federal Reserve Bank of New York

Abstract: This paper presents a theoretical model of exchange-rate determination intended to address the forward premium puzzle. It also explains the empirical observation that risk premiums depend on interest differentials. The model's closed-form solution indicates that currency risk premiums depend on two factors: interest differentials and the current deviation of the exchange rate from its long-run equilibrium. If speculators have an alternative to exchange-rate speculation, then there is no presumption that uncovered interest parity holds even approximately in long-run equilibrium. The model is consistent with existing evidence suggesting that forward premiums are negatively related to rationally expected future exchange rate changes. New empirical evidence is provided in support of the model.

Keywords: Forecasting; Foreign exchange rates (search for similar items in EconPapers)
Date: 1999
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Determinants of Currency Risk Premiums (1998)
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