Foreign Exchange Risk Premium: Does Fiscal Policy Matter? Evidence From Italian Data

Abstract

This is a Working Paper and the author(s) would welcome any comments on the present text. Citations should refer to a Working Paper of the International Monetary Fund. The views expressed are those of the author(s) and do not necessarily represent those of the Fund.

Exchange Rate Risk and Convergence to the Euro

“…As implied above, this exchange rate risk premium is attributable mainly to the fiscal policy outlook (Giorgianni, 1997;Favero and Giavazzi, 2004) as well as wage and price flexibility. The risk premium term is derived from a standard portfolio choice model with a constant absolute risk aversion  (Jeanne and Rose, 2002;Bacchetta and van Wincoop, 2004).…”

Perspectives on High Real Interest Rates in Turkey

“…The first is the public sector's debt-to-GDP ratio. Higher debt ratios have been found to be associated with higher risk premiums both in the term structure of interest rates (Favero and Giavazzi (2002)) and in the foreign exchange market (Giorgianni (1997)). The second variable we consider is the inflation rate.…”

“…As a benchmark, steady-state real interest rates for the US are typically estimated at about 4 percent (see Cooley and Prescott (1995) for estimates from the business cycle literature and Laubach and Williams (2003) for a Kalman filter approach), suggesting real interest rates in Turkey of about 9 percent. To further investigate the behavior of the risk premium, we study the implications of the portfolio balance model of exchange rate determination, just as in Giorgianni (1997). The portfolio balance model attributes the risk premium to the fact that domestic and foreign bonds are imperfect substitutes.…”

“…In equilibrium, an increase in the relative supply of domestic bonds requires an increase in the expected excess return on the security. Following Giorgianni (1997), we estimate the following equation: where DEF e t refers to the expected budget deficit of the central government (relative to GDP) and DEF *e t refers to the foreign equivalent, of which we use the US.F 14 Table 6 presents the results from estimating equation 18. The data source for the budget deficit for Turkey is the same used in the previous section.…”

Exchange Rate Misalignment: An Application of the Behavioral Equilibrium Exchange Rate (Beer) to Botswana

“…A typical proxy is net foreign assets in levels or differences (e.g., Edwards, 1994;Clark and MacDonald, 1999). λ represents a risk premium factor, which may disturb the actual exchange rate in the short run and be assumed to depend on government income and expenditure (Giorgianni, 1997;Dufrenot and Yehoue, 2005).…”