Sarno, Lucio and Schneider, Paul and Wagner, Christian (2010): Properties of Foreign Exchange Risk Premiums.
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Abstract
We study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, defined as the tendency of highinterest rate currencies to appreciate rather than depreciate. These risk premiums arise endogenously from imposing the noarbitrage condition on the relation between the term structure of interest rates and exchange rates, and they compensate for both currency risk and interest rate risk. In the empirical analysis, we estimate risk premiums using an affine multicurrency term structure model and find that modelimplied risk premiums yield unbiased predictions for exchange rate excess returns. While interest rate risk affects the level of risk premiums, the time variation in excess returns is almost entirely driven by currency risk. Furthermore, risk premiums are closely related to global risk aversion, countercyclical to the state of the economy, and tightly linked to traditional exchange rate fundamentals.
Item Type:  MPRA Paper 

Original Title:  Properties of Foreign Exchange Risk Premiums 
Language:  English 
Keywords:  term structure; exchange rates; forward bias; predictability 
Subjects:  E  Macroeconomics and Monetary Economics > E4  Money and Interest Rates > E43  Interest Rates: Determination, Term Structure, and Effects F  International Economics > F3  International Finance > F31  Foreign Exchange G  Financial Economics > G1  General Financial Markets > G10  General 
Item ID:  26132 
Depositing User:  Christian Wagner 
Date Deposited:  23. Oct 2010 00:24 
Last Modified:  13. Feb 2013 15:33 
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URI:  http://mpra.ub.unimuenchen.de/id/eprint/26132 
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Properties of Foreign Exchange Risk Premia. (deposited 13. Mar 2010 10:58)
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