Macroeconomic sources of foreign exchange risk premium: evidence from South Africa.

This study investigates the macroeconomic sources of foreign exchange risk premium in South Africa using the stochastic discount factor (SDF) approach based on observable macroeconomic factors. Using the multivariate GARCH-in-mean model with no-arbitrage condition, I find support for the role of nominal and real macroeconomic factors as important determinants of foreign exchange risk premium in South Africa. However, while inflation rate and broad money growth are associated higher risk premium, consumption growth appears to be associated with lower risk premium. Finally, the time varying nature of foreign exchange risk premia in South Africa suggest that, policymakers in South Africa need to broaden their analysis of fluctuations in foreign exchange rates to include an assessment of the foreign exchange risk premia. [ABSTRACT FROM AUTHOR]