IDEAS home Printed from https://ideas.repec.org/p/ucm/doicae/0412.html
   My bibliography  Save this paper

Macroeconomic and policy uncertainty and Exchange rate risk Premium

Author

Abstract

The goal of this paper is to identify the main determinants of the risk premium in some European currency markets just before the EMU. To that extent, we start from Lucas (1982) exchange rate model and derive an analytical expression for the forward premium. This expression includes money and production variables and it is quite standard, except for the inclusion of macroeconomic policy risk. Under some standard assumptions, this formula simplifies substantially and becomes amenable to regression analysis. Then, using standard measures of money and production, as well as interest rate swap spreads as indicators of macroeconomic policy risk, the theoretical expression is estimated. We provide evidence suggesting that it is policy uncertainty, much more than fundamental macroeconomic uncertainty, which determined risk premium over the convergence process to the euro. Whether these results can be extended to similar experiences for other currency unions remains open for future research.

Suggested Citation

  • Juan-Ángel Jiménez-Martín & Rodrigo Peruga Urrea, 2004. "Macroeconomic and policy uncertainty and Exchange rate risk Premium," Documentos de Trabajo del ICAE 0412, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    • Handle: RePEc:ucm:doicae:0412
    as

    Download full text from publisher

    File URL: https://eprints.ucm.es/id/eprint/7726/1/0412.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Favero, Carlo A. & Giavazzi, Francesco & Iacone, Fabrizio & Guido Tabellini, 2000. "Extracting information from asset prices: The methodology of EMU calculators," European Economic Review, Elsevier, vol. 44(9), pages 1607-1632, October.
    2. Soderlind, Paul & Svensson, Lars, 1997. "New techniques to extract market expectations from financial instruments," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 383-429, October.
    3. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August.
    4. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 433-459, May.
    5. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    6. Zivot, Eric & Andrews, Donald W K, 2002. "Further Evidence on the Great Crash, the Oil-Price Shock, and the Unit-Root Hypothesis," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 25-44, January.
    7. Hu, Xiaoqiang, 1997. "Macroeconomic uncertainty and the risk premium in the foreign exchange market1," Journal of International Money and Finance, Elsevier, vol. 16(5), pages 699-718, September.
    8. Kaminsky, Graciela & Peruga, Rodrigo, 1991. "Credibility crises: the dollar in the early 1980s," Journal of International Money and Finance, Elsevier, vol. 10(2), pages 170-192, June.
    9. Krasker, William S., 1980. "The `peso problem' in testing the efficiency of forward exchange markets," Journal of Monetary Economics, Elsevier, vol. 6(2), pages 269-276, April.
    10. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
    11. Banerjee, Anindya & Lumsdaine, Robin L & Stock, James H, 1992. "Recursive and Sequential Tests of the Unit-Root and Trend-Break Hypotheses: Theory and International Evidence," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 271-287, July.
    12. Lewis, Karen K., 1988. "The persistence of the `peso problem' when policy is noisy," Journal of International Money and Finance, Elsevier, vol. 7(1), pages 5-21, March.
    13. Bekaert, Geert & Hodrick, Robert J, 1992. "Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 467-509, June.
    14. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    2. Jiménez-Martín, Juan-Ángel & Cinca, Alfonso Novales, 2010. "State-uncertainty preferences and the risk premium in the exchange rate market," Economic Modelling, Elsevier, vol. 27(5), pages 1043-1053, September.
    3. Stuart Landon & Constance E. Smith, 2003. "The Risk Premium, Exchange Rate Expectations, and the Forward Exchange Rate: Estimates for the Yen–Dollar Rate," Review of International Economics, Wiley Blackwell, vol. 11(1), pages 144-158, February.
    4. Dios Palomares, Rafaela & Martínez Paz, José Miguel & Martínezcarrasco Pleite, Federico, 2006. "Including environmental variables in the effi ciency analysis: A three-step method/El análisis de efi ciencia con variables de entorno: un método de programas con tres etapas," Estudios de Economia Aplicada, Estudios de Economia Aplicada, vol. 24, pages 477-497, Abril.
    5. Ping-Yu Chen & Chia-Lin Chang & Chi-Chung Chen & Michael McAleer, 2010. "Modeling the Volatility in Global Fertilizer Prices," Working Papers in Economics 10/46, University of Canterbury, Department of Economics and Finance.
    6. Franses,Philip Hans & Dijk,Dick van & Opschoor,Anne, 2014. "Time Series Models for Business and Economic Forecasting," Cambridge Books, Cambridge University Press, number 9780521520911, October.
    7. Ross Levine, 1988. "The forward exchange rate bias: a new explanation," International Finance Discussion Papers 338, Board of Governors of the Federal Reserve System (U.S.).
    8. John D. Levendis, 2018. "Time Series Econometrics," Springer Texts in Business and Economics, Springer, number 978-3-319-98282-3, April.
    9. Ping-Yu Chen & Chia-Lin Chang & Chi-Chung Chen & Michael McAleer, 2010. "Modeling the Effect of Oil Price on Global Fertilizer Prices," KIER Working Papers 722, Kyoto University, Institute of Economic Research.
    10. repec:rri:wpaper:200501 is not listed on IDEAS
    11. Canova, Fabio & Marrinan, Jane, 1995. "Predicting excess returns in financial markets," European Economic Review, Elsevier, vol. 39(1), pages 35-69, January.
    12. Thomas Chiang & Sheng-Yung Yang, 2005. "International Asset Excess Returns and Multivariate Conditional Volatilities," Review of Quantitative Finance and Accounting, Springer, vol. 24(3), pages 295-312, May.
    13. Karen K. Lewis, 2011. "Global Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 435-466, December.
    14. Zeynel Abidin Ozdemir, 2010. "Dynamics Of Inflation, Output Growth And Their Uncertainty In The Uk: An Empirical Analysis," Manchester School, University of Manchester, vol. 78(6), pages 511-537, December.
    15. P. Kearns & A.R. Pagan, 1993. "Australian Stock Market Volatility: 1875–1987," The Economic Record, The Economic Society of Australia, vol. 69(2), pages 163-178, June.
    16. Levent, Korap, 2009. "Enflasyon ve enflasyon belirsizliği ilişkisi için G7 ekonomileri üzerine bir inceleme [An investigation for the inflation and inflation uncertainty relationship upon the G7 economies]," MPRA Paper 19478, University Library of Munich, Germany.
    17. Dumas, Bernard & Solnik, Bruno, 1995. "The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-479, June.
    18. Amir Kia, 2006. "Deficits, Debt Financing, Monetary Policy and Inflation in Developing Countries: Internal or External Factors? Evidence from Iran," Carleton Economic Papers 06-03, Carleton University, Department of Economics, revised Nov 2006.
    19. Aggarwal, Divya, 2019. "Do bitcoins follow a random walk model?," Research in Economics, Elsevier, vol. 73(1), pages 15-22.
    20. Salisu, Afees A. & Mobolaji, Hakeem, 2013. "Modeling returns and volatility transmission between oil price and US–Nigeria exchange rate," Energy Economics, Elsevier, vol. 39(C), pages 169-176.
    21. Tuysuz, Sukriye, 2007. "The asymmetric impact of macroeconomic announcements on U.S. Government bond rate level and volatility," MPRA Paper 5381, University Library of Munich, Germany.

    More about this item

    Keywords

    Risk premium; Peso Problem; Macroeconomic policy risk; European monetary System.;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ucm:doicae:0412. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Águeda González Abad (email available below). General contact details of provider: https://edirc.repec.org/data/feucmes.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.