This paper proposes an equilibrium theory of nominal exchange rates, which offers a new perspective on various issues in open economy macroeconomics. The rate and portfolio choices are jointly determined equilibrium, thus providing approach to overcoming the indeterminacy results Kareken Wallace (1981). distinctive features this that is international financial markets, risk premium UIP deviatio...

We use a present-value model of the real exchange rate to impose structure on currency risk premium. allow premium depend both interest differential and latent component: missing Consistent with data, our implies that should predict returns. find premium, not differential, explains most variation in rate. Moreover, sheds light puzzling relations between rate,