Countercyclical currency risk premia
Name
Verdelhan_Countercyclical.pdf
Size
441.57 KB
Format
Adobe PDF
Checksum (MD5)
ad863e078040a5bed04347ae5938b13f
Author(s)
Lustig, Hanno
Roussanov, Nikolai
Verdelhan, Adrien Frederic
Date Issued
December 2013
Journal
Journal of Financial Economics
Publisher
Elsevier
Citation
Lustig, Hanno et al. “Countercyclical Currency Risk Premia.” Journal of Financial Economics 111, 3 (March 2014): 527–553 © 2013 Elsevier B.V.
Version
Original manuscript
Abstract
We describe a novel currency investment strategy, the ‘dollar carry trade,’ which delivers large excess returns, uncorrelated with the returns on well-known carry trade strategies. Using a no-arbitrage model of exchange rates we show that these excess returns compensate U.S. investors for taking on aggregate risk by shorting the dollar in bad times, when the U.S. price of risk is high. The countercyclical variation in risk premia leads to strong return predictability: the average forward discount and U.S. industrial production growth rates forecast up to 25% of the dollar return variation at the one-year horizon. The estimated model implies that the variation in the exposure of U.S. investors to worldwide risk is the key driver of predictability. Keywords: Exchange rates; Forecasting; Risk
MIT Department
Sloan School of Management
Terms of Use
Creative Commons Attribution-NonCommercial-NoDerivs License
Persistent DSpace Link
DOI of Published Version
https://doi.org/10.1016/J.JFINECO.2013.12.005
