Properties of Foreign Exchange Risk Premiums

Lucio Sarno, Paul Schneider () and Christian Wagner ()

Working Paper series from Rimini Centre for Economic Analysis

Abstract: We study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, defined as the tendency of high-interest rate currencies to appreciate rather than depreciate. These risk premiums arise endogenously from the no-arbitrage condition relating the term structure of interest rates and exchange rates. Estimating affine (multi-currency) term structure models reveals a noticeable tradeoff between matching depreciation rates and accuracy in pricing bonds. Risk premiums implied by our global affine model generate unbiased predictions for currency excess returns and are closely related to global risk aversion, the business cycle, and traditional exchange rate fundamentals.

Keywords: term structure; exchange rates; forward bias; predictability (search for similar items in EconPapers)
JEL-codes: E43 F31 G10 (search for similar items in EconPapers)
Date: 2012-03
New Economics Papers: this item is included in nep-ifn, nep-mon and nep-upt
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Citations: View citations in EconPapers (74)

Published in Journal of Financial Economics, 105(2):279-310, 2012

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http://www.rcea.org/RePEc/pdf/wp10_12.pdf (application/pdf)

Related works:
Journal Article: Properties of foreign exchange risk premiums (2012)
Working Paper: Properties of Foreign Exchange Risk Premiums (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:rim:rimwps:10_12

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