Long-Term Foreign Exchange Risk Premia and Inflation Risk

59 Pages Posted: 7 Oct 2020

See all articles by Fabio Moneta

Fabio Moneta

Telfer School of Management, University of Ottawa

Daehwan Kim

Konkuk University

Date Written: August 19, 2020

Abstract

As highlighted by recent literature, long-term foreign exchange risk premia (FRP) of a currency pair tend to covary negatively with short-term real interest rates differentials (RIRD) of the pair. We fit an affine term structure model for 9 major currencies against the US dollar and estimate two components of this covariance: the real risk premia (RRP) component and the inflation risk premia differential (IRPD) component. We find that the IRPD component is significantly negative for all currency pairs in our sample. We propose a macro-finance model to understand the type of shocks that generates such covariance.

Keywords: Foreign exchange risk premia, real interest rates, inflation risk, affine term structure model, inflation volatility

JEL Classification: E43, F31, G15

Suggested Citation

Moneta, Fabio and Kim, Daehwan, Long-Term Foreign Exchange Risk Premia and Inflation Risk (August 19, 2020). Available at SSRN: https://ssrn.com/abstract=3677302 or http://dx.doi.org/10.2139/ssrn.3677302

Fabio Moneta

Telfer School of Management, University of Ottawa ( email )

136 Jean-Jacques Lussier Street
Ottawa, Ontario K1N 6N5
Canada

Daehwan Kim (Contact Author)

Konkuk University ( email )

1 Hwayang-dong
Kwangjin-gu
Seoul, 143-701
Korea

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