Abstract
This paper tests the null of a constant risk premium against an alternative where the risk premium changes with regimes. The reduced form equations for the spot rate and the net supply of foreign assets are derived from a portfolio model and a flow equation for the current account. Regime changes alter the spot rate forecast variance and consequently change demand elasticities and reduced form parameters. Using data for 1964-83 and permitting regime changes in 1969, 1973, and 1979, we fit our model with FIML to impose all the theoretical restrictions. In some specifications we find evidence for risk aversion.
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