Resolving the forward premium puzzle requires a volatile foreign exchange rate risk premium that covaries negatively with the expected depreciation rate. Earlier work has shown how models featuring consumption habits can generate such premia when either trade costs or ‘deep habits' are...

Foreign-currency exposures on an economy's external balance sheet may jeopardize financial stability when the exchange rate depreciates. In fact, theory suggests that in such an environment it may be optimal for monetary policy in a floating regime to reduce exchange rate variation in order to...