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.
More evidence on the dollar risk premium in the foreign exchange market
