Rangan Varadan
Published: 1998
Total Pages: 290
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In the second essay presented in Chapter III, I explain the failure of UFRH based on the argument of existence of time-varying risk premium. I investigate the pricing of forward contracts in the context of conditional international asset pricing models. In contrast to much of this previous work, I consider generalizations in two important dimensions. First, the international asset pricing model (IAPM) is specified in a conditional environment. Second, in this chapter I treat the pricing of forward contracts in a framework that allows for more than one source of risk. The strongest support to the model's restrictions comes from using a set of country-specific variables in a two-factor setting. This implies that, in the forward exchange market, the exchange, rate risk is an important factor. Furthermore, the evidence supports the idea that deviations from the expected future spot rate are due to a risk premium.