Estimates of foreign exchange risk premia: a pricing kernel approach

The goal of this study is to measure market prices of risk and foreign exchange risk premia. Estimations of minimum variance pricing kernels permit to determine market prices of risk, which, in an international no-arbitrage framework, allow to measure foreign exchange risk premia. Market prices of risk are time-varying and surge during financial turmoils. Foreign exchange risk premia are on average small in comparison to interest rate differentials and exhibit significant variation from the early 1970s onwards, when the Bretton Woods exchange rate system collapsed. At times, foreign exchange risk premia dominate interest rate differentials.