Stationary time-varying risk premia in forward foreign exchange rates

There is mounting evidence that forward foreign exchange rates contain time-varying risk premia. However, this evidence is from tests for which statistical inference is based on asymptotic distribution theory. Furthermore, it is uncertain whether risk premia evolve as stationary or nonstationary processes. This paper applies two exact small-sample, pointwise most powerful invariant statistical tests to determine (1) whether forward exchange rates contain time varying risk premia, and (2) whether the time-varying risk premia are stationary or nonstationary. These tests finds strong evidence that forward exchange rates contain stationary, time varying risk premia during the recent float; evidence from the interwar float is mixed. (C) 2000 Elsevier Science Ltd. All rights reserved. JEL classification: F31; G13; C12.