Determinants of the Foreign Exchange Risk Premium in Gulf Cooperation Council Countries
IMF Working Papers, November 1, 2010
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Bibliographic details
- Authors: Tigran Poghosyan
- Published: November 1, 2010
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781455209552.001
Summary
- Paper analyzes macroeconomic determinants of the foreign exchange risk premium in two Gulf Cooperation Council (GCC) countries that peg their currencies to the U.S. dollar: Saudi Arabia and the United Arab Emirates.
- Analysis is based on the stochastic discount factor methodology, which imposes a no arbitrage condition on the relationship between the foreign exchange risk premium and its macroeconomic determinants.
- The methodology can be used for forecasting the risk premium on a monthly basis, with practical implications for policymakers interested in timely monitoring of risks in the GCC.
- Publication date: November 1, 2010.
- Pages: 24.
- Issue: 255.
- Series: Working Paper No. 2010/255.
- DOI: https://doi.org/10.5089/9781455209552.001.
- ISBN: 9781455209552.
- ISSN: 1018-5941.
Methodology
- Uses the stochastic discount factor methodology to impose a no arbitrage condition relating the foreign exchange risk premium to macroeconomic determinants.
- Employs multivariate GARCH-in-Mean and variance-covariance matrix constructs (as indicated in keywords) to model a time-varying risk premium and obtain the risk premium expression.
Key empirical findings
- U.S. inflation is an important factor driving the foreign exchange risk premium.
- U.S. consumption growth is an important factor driving the foreign exchange risk premium.
- Growth in international oil prices influences the risk premium, reflecting the important role played by the hydrocarbon sector in GCC economies.
- Findings are consistent with the standard C-CAPM model.
Policy implications and practical applications
- Monthly forecasting of the foreign exchange risk premium is feasible using the employed methodology.
- Timely monitoring of the risk premium can inform policymakers in pegged-currency GCC economies (Saudi Arabia and the United Arab Emirates) about evolving foreign exchange risks.
- Because oil price growth affects the risk premium, monitoring international oil price dynamics is relevant for macrofinancial risk assessment in GCC countries.
Subjects and keywords (as listed)
- Subjects: Consumption, Currencies, Exchange rate risk, Financial regulation and supervision, Money, National accounts, Oil prices, Prices, Return on investment.
- Keywords: Consumption, covariance term, Currencies, exchange rate, Exchange rate risk, foreign exchange, foreign exchange risk, foreign exchange risk premium, GCC, Global, multivariate GARCH‑in‑Mean, obtained risk premium expression, oil price, Oil prices, Return on investment, time‑varying risk premium, variance‑covariance matrix, WP.
Source: IMF Working Paper by Tigran Poghosyan, "Determinants of the Foreign Exchange Risk Premium in Gulf Cooperation Council Countries", November 1, 2010, Working Paper No. 2010/255.
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- _wp10255 - References