International Trade and the Risk Premium in the Currency Forward Market

International Trade and the Risk Premium in the Currency Forward Market

In this paper we present an intertemporal model of the spot and forward markets for foreign exchange. We analyze the implications of central bank interventions on the spot market for the risk premium in the currency forward market and discuss the consequences for the allocation of exchange rate risk and for the volume of international trade. As a main result we find that exchange rate volatility does not generate systematic risk and hence does not adversely affect international trade as long as the monetary authorities do not exogenously intervene in the foreign exchange spot market. (JEL Classification: F11, F31, F33)