Exchange rate risk and deviations from purchasing power parity

Arghyrou, Michael, Lu, Wenna and Pourpourides, Panayiotis ORCID: https://orcid.org/0000-0002-2986-4094 2025. Exchange rate risk and deviations from purchasing power parity. International Journal of Finance & Economics 10.1002/ijfe.3160

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Abstract

This paper proposes a new solution to the purchasing power parity (PPP) puzzles, arguing that investors' higher-order risk attitudes, combined with higher-order uncertainty about nominal exchange rates, as reflected by skewness and kurtosis, drive a risk premium that leads to deviations from PPP. Analysing US dollar exchange rates against the currencies of three major net exporting countries to the US – Canada, Japan, and the European Union – we find that the skewness of the expected nominal exchange rate is the most significant and statistically robust moment-based factor influencing these deviations. Our estimates further suggest that only low to moderate exchange rate risks generate risk premia that contribute to these PPP deviations.

Item Type:	Article
Date Type:	Published Online
Status:	In Press
Schools:	Schools > Business (Including Economics)
Subjects:	T Technology > TX Home economics
Publisher:	Wiley
ISSN:	1076-9307
Date of First Compliant Deposit:	17 March 2025
Date of Acceptance:	16 March 2025
Last Modified:	07 Apr 2025 11:42
URI:	https://orca.cardiff.ac.uk/id/eprint/176925

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