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Macroeconomic and policy uncertainty and exchange rate risk premium

Jiménez Martín, Juan Ángel and Peruga Urrea, Rodrigo (2004) Macroeconomic and policy uncertainty and exchange rate risk premium. [Working Paper or Technical Report]

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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.

Item Type:Working Paper or Technical Report
Additional Information:JEL Classification: F31, F41, G12, G15
Uncontrolled Keywords:Risk premium, Peso Problem, Macroeconomic policy risk, European monetary System
Subjects:Social sciences > Economics > Econometrics
Series Name:Documentos de trabajo del Instituto Complutense de Análisis Económico (ICAE)
Volume:2004
Number:0412
ID Code:7726
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Deposited On:11 Mar 2008
Last Modified:06 Feb 2014 07:55

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