Countercyclical currency risk premia

Hanno Lustig, Nikolai Roussanov and Adrien Verdelhan ()

Journal of Financial Economics, 2014, vol. 111, issue 3, 527-553

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 (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (149)

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Working Paper: Countercyclical Currency Risk Premia (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:111:y:2014:i:3:p:527-553

DOI: 10.1016/j.jfineco.2013.12.005

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