Risk Premium Estimation in the Colombian Foreign Exchange Market

Abstract

We studied the foreign exchange risk premium in the Colombian market for the USD/COP exchange rate. Likewise most literature, we consider the existence of the risk premium, as we assessed the problem considering future contracts prices and spot prices at four different times of the morning. Furthermore, we found statistically significant evidence to consider the risk premium as time-varying due to different results in the estimations depending of the time of the day. Finally, in contrast with the early morning regressions, we encountered evidence that the estimation of the foreign exchange risk premium was statistically significant only in late hours of the morning, i.e., only at 11:00 and 12:00 suggesting that the exchange market may valuate more adequately the futures in the late morning hours. This can be explained by the fact that early transactions have higher volatility and may miss important information that the market include as the day advances.

Keywords: risk premium, foreign exchange risk premium, foreign exchange, exchange rate, Colombia

JEL Classification: F31, G13