Uncertainty and risk premium puzzle

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

This paper provides a theory and evidence that the risk premium puzzle may be viewed mainly as a phenomenon pertaining to the unstable foreign exchange market. In an unstable market, errors uncompensated by an initial risk premium accrue due to consumer expectation revision about the ex ante uncertainty of the exchange rate. These revision errors are different from the forecasting errors, depending on the frequency of the consumer expectation revision and the degree of risk aversion. A simulation was discussed on how the risk premium actually deviates from an initial premium in the unstable market. Using the monthly data of the U. K., Japan, Australia, Korea, Malaysia, and Thailand from January 1994 to December 2008, it is shown that revision errors for risk premium were statistically significant and were non-trivial in magnitude and that the degree of absolute risk aversion went up during the Asian currency crisis as well as the recent financial crisis periods.

Original languageEnglish
Pages (from-to)62-79
Number of pages18
JournalJournal of Economics and Finance
Volume37
Issue number1
DOIs
StatePublished - Jan 2013

Keywords

  • Forward Premium Anomaly
  • Premium Puzzle
  • Revision Error
  • Risk Aversion

Fingerprint

Dive into the research topics of 'Uncertainty and risk premium puzzle'. Together they form a unique fingerprint.

Cite this