This paper finds strong evidence of a positive relationship between currency risk premia and real exchange rate swings, significant at the 1% if not 0.1% level, for three US$ exchange rate samples. The risk premia are measured using survey data on traders' exchange rate forecasts. This circumvents the need for an auxiliary hypothesis of rationality and enables more direct focus on risk behavior. The analysis is conducted using the I(2) cointegrated VAR, which allows for time-varying trends in the variables. Evidence of persistent changes is found for interest rates, prices, and nominal and real exchange rates. Interest rate shocks appear to drive the system, whereas expectations are correcting only in the longer run.
