International asset pricing with time-varying risk premia

Recent empirical evidence that forward exchange rates are biased predictors of future spot rates can also be interpreted as evidence against the hypothesis of a constant risk premium. Consequently, reconciliation of this evidence with efficient international capital markets requires the existence of time-varying risk premia. This paper modifies Kouri's (1977) asset pricing model to allow time-varying exected returns on assets, eliminates the assumption of a risk-free real asset and derives the characteristics of the risk premia in the forward market as well as the equilibrium yield relationships among the equities and riskless nominal bonds of all countries.