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Effect of net foreign assets on persistency of time-varying risk premium: Evidence from the Dollar-Yen exchange rate

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  • Shimizu, Makoto
Abstract
In this paper, I focus on the time-varying and persistent exchange rate risk premiums in uncovered interest rate parity associated with changes in net foreign assets. The results of my analyses of the Dollar-Yen exchange rate provide evidence consistent with my risk premium formulation and the predictability of current account balances. I contend that the strong persistent effect causes nominal exchange rates to appear non-stationary in level. I also argue that the present value model of the level of exchange rates combined with the AR(1) approximation for interest rate differentials can reconcile a failure of uncovered interest rate parity.

Suggested Citation

  • Shimizu, Makoto, 2017. "Effect of net foreign assets on persistency of time-varying risk premium: Evidence from the Dollar-Yen exchange rate," International Review of Economics & Finance, Elsevier, vol. 49(C), pages 255-265.
    • Handle: RePEc:eee:reveco:v:49:y:2017:i:c:p:255-265
    DOI: 10.1016/j.iref.2017.01.022
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    1. Engel, Charles, 2014. "Exchange Rates and Interest Parity," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 453-522, Elsevier.
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    7. Li, Dandan & Ghoshray, Atanu & Morley, Bruce, 2012. "Measuring the risk premium in uncovered interest parity using the component GARCH-M model," International Review of Economics & Finance, Elsevier, vol. 24(C), pages 167-176.
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    10. Chinn, Menzie D., 2006. "The (partial) rehabilitation of interest rate parity in the floating rate era: Longer horizons, alternative expectations, and emerging markets," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 7-21, February.
    11. Lustig, Hanno & Stathopoulos, Andreas & Verdelhan, Adrien, 2016. "Nominal Exchange Rate Stationarity and Long-Term Bond Returns," Research Papers 3411, Stanford University, Graduate School of Business.
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    Cited by:

    1. Chen, W.D., 2020. "Liquidity, covered interest rate parity, and zero lower bound in Japan’s foreign exchange markets," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 334-349.
    2. Makoto Shimizu, 2020. "The Present-Value Model of the Exchange Rate with a Persistently Time-Varying Risk Premium: Evidence from the Dollar-Yen Rate," Open Economies Review, Springer, vol. 31(5), pages 1037-1059, November.

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    More about this item

    Keywords

    Uncovered interest rate parity; Time-varying risk premium; Nominal exchange rate stationarity; Current account balance;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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