Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 43: International Portfolio Diversification and the Foreign Exchange Risk Premium

Marianne Nessén ()
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Marianne Nessén: Dept. of Finance, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden

Abstract: A multi-country model of intertemporal portfolio choice and the foreign exchange risk premium which incorporates both nominal price and relative price risk is developed. Portfolio demands are derived and interpreted in terms of diversification and hedge portfolios. The equilibrium foreign exchange risk premium is then analyzed and discussed in terms of e.g. relative and nominal price uncertainty. Special attention is paid to the effects of deviations from purchasing power parity.

Keywords: Risk premium model; international portfolio diversification

JEL-codes: E44; E41; G15

43 pages, December 1994

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