Exchange Rates, Expected Returns and Risk: What Can We Learn from Asia-Pacific Currencies?

Abstract

This paper employs a risk-augmented asset price model of the exchange rate to compare the risk and return characteristics of a range of Asia-Pacific USD currency pairs. The Asia-Pacific currencies include a full range of exchange rate regimes, so provide a broad perspective of exchange rate behaviour. The results suggest that more managed exchange rates are associated with higher variance of the relative “bond premium” (the difference between observed interest rates and the underlying risk-free rate), lower variance of the “currency premium” (currency-specific premia and/or long-run fundamentals), and a slightly higher degree of risk-sharing. The results point to a role for risk and risk sharing in monetary policy trilemma tradeoffs.

Full publication: Cross-Border Financial Linkages: Challenges for Monetary Policy and Financial Stability

Keywords: exchange rate, asset price, currency risk, monetary policy trilemma, AsiaPacific

JEL Classification: F31, G12