Abstract
The risk premium is a function of both the interest rate differential and the gap between the current exchange rate and its long-run equilibrium in a model of the foreign exchange market with both non-speculating traders and rational speculators. If the speculators have an alternative to specializing in exchange-rate speculation, then there should be no presumption that uncovered interest rate parity will hold even approximately with a long-run equilibrium number of speculators. Furthermore, when other traders respond to interest-rate differentials, the model can give rise to a negative relationship between the interest-rate differential and the subsequent change in the exchange rate, a phenomenon that is often evident in foreign exchange markets.
Keywords
International Financial Market, Currencies, Exchange Rate
Tech Report Number
1998-006
Date of this Version
1998
Recommended Citation
Carlson, J. A. and Osler, C. L., "Determinants of Currency Risk Premiums" (1998). Purdue CIBER Working Papers. Paper 134.
https://docs.lib.purdue.edu/ciberwp/134