Common Risk Factors in Currency Markets

Nikolai Roussanov, Adrien Verdelhan () and Hanno Lustig

No 711, 2008 Meeting Papers from Society for Economic Dynamics

Abstract: We build portfolios of monthly currency forward contracts sorted on forward discounts. The spread between returns on the lowest and highest interest rate currency portfolios is more than 5 percentage points per annum between 1983 and 2007 after taking into account bid-ask spreads. The annualized Sharpe ratio on a carry trade strategy that goes long in the highest and short in the lowest interest rate currency basket is 0.6. We provide new evidence for a systematic risk explanation of these currency excess returns. We show that a single common risk factor accounts for their cross-sectional variation. We find that these excess returns are highly predictable over time and that expected excess returns are strongly counter-cyclical, supporting the view that currency excess returns are compensation for bearing macroeconomic risk. We show that a simple affine framework reproduces both cross-sectional and predictability results.

Date: 2008
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Citations: View citations in EconPapers (31)

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Related works:
Journal Article: Common Risk Factors in Currency Markets (2011)
Working Paper: Common Risk Factors in Currency Markets (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed008:711

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