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Implied Foreign Exchange Risk Premia

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  • Nikolaos Panigirtzoglou

Abstract

This paper uses implied volatilities from foreign exchange option prices and the results of no‐arbitrage theory to estimate foreign exchange risk premia. In particular, under the assumption of no‐arbitrage, the foreign exchange risk premium is driven by the difference between investors’ market prices of risk in the two currencies. In an international economy with three currencies, sterling, US dollar and Deutschemark, we can use the information on implied volatilities of the three cross rates to derive estimates of implied or ex ante market prices of risk and of foreign exchange risk premia. The foreign exchange risk premia estimates are then compared to survey‐based risk premia.

Suggested Citation

  • Nikolaos Panigirtzoglou, 2004. "Implied Foreign Exchange Risk Premia," European Financial Management, European Financial Management Association, vol. 10(2), pages 321-338, June.
    • Handle: RePEc:bla:eufman:v:10:y:2004:i:2:p:321-338
    DOI: 10.1111/j.1354-7798.2004.00252.x
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    References listed on IDEAS

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    1. Michael W. Brandt & John H. Cochrane & Pedro Santa-Clara, 2001. "International Risk Sharing is Better Than You Think (or Exchange Rates are Much Too Smooth)," NBER Working Papers 8404, National Bureau of Economic Research, Inc.
    2. Campbell, John Y., 1999. "Asset prices, consumption, and the business cycle," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 19, pages 1231-1303, Elsevier.
    3. Robin Brooks & Hali Edison & Manmohan S. Kumar & Torsten Sløk, 2004. "Exchange Rates and Capital Flows," European Financial Management, European Financial Management Association, vol. 10(3), pages 511-533, September.
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    Cited by:

    1. Carmen Gloria Silva, 2010. "Forward premium puzzle and term structure of interest rates: the case of New Zealand," Working Papers Central Bank of Chile 570, Central Bank of Chile.
    2. Astrid Eisenberg & Markus Rudolf, 2007. "Exchange Rates and the Conversion of Currency‐Specific Risk Premia," European Financial Management, European Financial Management Association, vol. 13(4), pages 672-701, September.
    3. Lorenzo Cappiello & Nikolaos Panigirtzoglou, 2008. "Estimates of foreign exchange risk premia: a pricing kernel approach," Empirical Economics, Springer, vol. 35(3), pages 475-495, November.
    4. Kumar, Satish & Trück, Stefan, 2014. "Unbiasedness and risk premiums in the Indian currency futures market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 29(C), pages 13-32.

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