Identification And Testing Of A Term Structure Relationship For Country And Currency Risk Premia In An Emerging Market

This paper uses a term structure of Mexican sovereign debt to create measures of country and currency risk premia. We use these measures to test hypothesis about investors' expectations regarding these risks and their relationship to volatility in securities markets. In the period 1993-94, the behavior of these two risk premia are markedly different. Interestingly, the currency premium is considerably larger and more volatile than its country risk counterpart. We find that increases in stock return volatility translate into increases in the premium demanded by investors with respect to currency and country factors. Investors appear to have long memories, in that the premia are more persistent than equity market volatility shocks.