Impact of a Risk Premium on the Empirical Testing of FOREX - Essay Example

In line with this, the empirical tests test for the availability of atypical or risk –accustomed earning opportunities. However, in the case of ambiguity and uncertain venture such as spot and forward (JACQUE, 2014) speculation, it is complex to interpret the empirical tests relative to the market efficiency. The fundamental model applied in testing marketing efficiency is the joint hypothesis, which means that two hypotheses are tested at the same time. In such cases, when the risk premium is in existence it creates an impact which shifts the equilibrium return on currency trading toward a high point.

This implies that, the profits attributed to the currency trading do not show market inefficiency if these returns are fewer than the suitable risk premium (ULLRICH, 2009). This impact can be explained by an example of a corporation, which hedges, and in return, its financial experience to the currency risk reduces. This implies that, in the absence of a risk premium, the firm does not sacrifice any return in the process of risk reduction. If the corporation faces high cost of financial misery, then this nature of reduced volatility will benefit its operations (RECORD, 2003).

This implies that the effect of risk premium on a firm is immensely attributed to the hedging of a corporation when the risk premium exists. In addition, the risk premium on empirical testing invokes significance and negative relationship with the expected future spot rate. In addition, the premium risk offers a more explanatory note relative.