THE RISK PREMIUM IN THE FOREIGN EXCHANGE MARKET. THE APPLICATION OF ARCH-IN-MEAN MODEL
THE RISK PREMIUM IN THE FOREIGN EXCHANGE MARKET. THE APPLICATION OF ARCH-IN-MEAN MODEL

Summary/Abstract: Forward premium anomaly is one of the most popular puzzles in the theory of international finance. The phenomenon is explained by, among others, the existence of non-zero risk premium in the foreign exchange market. The paper applies ARCH-in-mean models to assess whether there exists a time-varying risk premium in the USD/PLN and AUD/JPY foreign exchange markets. The results indicate the existence of a non-zero risk premium in the analyzed markets. As far as the USD/PLN is concerned, the risk premium takes negative values when the risk measured by conditional variance rises. The results suggest that when there is a surge in risk, the US dollar’s appreciation and Polish zloty depreciation increases. The results confirm the US dollar as a safe-haven currency that tends to appreciate during high-volatility and crisis periods. Moreover, the study shows that the risk premium in the AUD/JPY market takes positive values when the risk measured by conditional variance rises. It implies that when there is a mount in risk, the appreciation of Japanese yen increases. Furthermore, research results reveal the positive and significant relationship between stock market uncertainty and exchange rates conditional volatility.

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