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Determinants of the Foreign Exchange Risk Premium in Gulf Cooperation Council Countries

Author/Editor: Poghosyan, Tigran
Authorized for Distribution: November 1, 2010
Electronic Access: Free Full Text (PDF file size is 1,275KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: This 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. The 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. Estimation results suggest that U.S. inflation and consumption growth are important factors driving the risk premium, which is in line with the standard C-CAPM model. In addition, growth in international oil prices influences the risk premium, reflecting the important role played by the hydrocarbon sector in GCC economies. The methodology employed in this paper can be used for forecasting the risk premium on a monthly basis, which has important practical implications for policymakers interested in the timely monitoring of risks in the GCC.
 
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Series: Working Paper No. 10/255
Subject(s): Consumption | Cooperation Council for the Arab States of the Gulf | Currency pegs | Economic models | Foreign exchange | Inflation | Oil prices | Risk premium | Saudi Arabia | United Arab Emirates | United States
Author's keyword(s): foreign exchange risk; time-varying risk premium; multivariate GARCH-in-Mean; GCC
 
English  
    Published:   November 1, 2010        
            Format:   Paper
    Stock No:   WPIEA2010255   Pages:   24
    Price:   US$18.00 (Academic Rate: US$18.00 )
       
     
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