Aggregate and Disaggregate Measures of the Foreign Exchange Risk Premium

Using a disaggregate survey data base, this paper re-examines the issue of the existence of a time-varying risk premia in three foreign exchange markets. Previous research on this topic has utilized a consensus measure of the risk premium, based on the rational expectations assumption, and is not supportive of the existence of such a premium. In contrast, this paper reports compelling evidence in favour of time-varying risk premia for the British pound, German mark and Japanese yen exchange rates. In particular, we demonstrate that consensus measures of the risk premium mask the existence of risk because of the importance of heterogeneous expectations