Hi, guys > need a help here!
On the page 552 bk1, “the real exchange rate =long run equilibrium exchange rate+real interest rate spread-risk premium spread”. I really dont understand that why the real exchange rate is negative correlated with risk premium spread?
Please somebody give a hand, thank you!
This is my first time looking at this material so I probably shouldn’t be giving advice. But based on how I read the equation, it is not claiming that the real exchange rate is negatively correlated with the risk premia spread. Instead I read it as: the real exchange rate = the real long-run equilibrium exchange rate + (the real interest rate spread minus the risk premia spread). They don’t appear to be correlated, just lumped together in the equation because they are both differentials.
If the domestic risk premia is higher than the foreign risk premia it is subtracted. If the domestic risk premia is lower than the foreign risk premia then it is added.