THE CROSS-SECTION OF FOREIGN CURRENCY RISK PREMIA AND CONSUMPTION GROWTH RISK

Adrien Verdelhan () and Hanno Lustig

No WP2005-019, Boston University - Department of Economics - Working Papers Series from Boston University - Department of Economics

Abstract: Aggregate consumption growth risk explains why low interest rate currencies do not appreciate as much as the interest rate di®erential and why high interest rate currencies do not depreciate as much as the interest rate di®erential. We sort foreign currency returns into portfolios based on foreign interest rates, and we test the Euler equation of a domestic investor who invests in these currency portfolios. We ¯nd that domestic investors earn negative excess returns on low interest rate currency portfolios and positive excess returns on high interest rate currency portfolios. Because high interest rate currencies depreciate on average when domestic consumption growth is low and low interest rate currencies do not under the same conditions, low interest rate currencies provide domestic investors with a hedge against domestic aggregate consumption growth risk.

Keywords: Exchange Rates; Asset Pricing. (search for similar items in EconPapers)
Pages: 51 pages
Date: 2005-06
New Economics Papers: this item is included in nep-fin, nep-fmk, nep-ifn and nep-mac
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Citations: View citations in EconPapers (12)

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Related works:
Journal Article: The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk (2007)
Working Paper: The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk (2006)
Working Paper: The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk (2006)
Working Paper: The Cross-Section of Foreign Currency Risk Premia and US Consumption Growth Risk (2004)
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