On the Time Varying Risk Premium in the Yen/Dollar Exchange Market

Abstract

The purpose of this paper is two-fold. First, a vector autoregressive model (VAR) is constructed to investigate the relative importance of monetary and real factors in the determination of the the yen/dollar exchange rate. Second, the forecasts from the VAR model are used to calculate a risk premium series. We show that real factors, represented by the stock price indices, statistically account f9r the dollar appreciation better than monetary factors, represented by the intere5t rates. The dynamic structure of interdependence between the exchange rate and the domestic variables changed considerably after October 1982. The risk premium calculated from the model shows a volatile and time-varying nature. The hypothesis of no risk premium is strongly rejected for the entire sample and each of the two subsamples considered.