Idiosyncratic consumption risk and predictability of the carry trade premium: Euro-Area evidence

Thomas Nitschka

Financial Markets and Portfolio Management, 2010, vol. 24, issue 1, 49-65

Abstract: The failure to empirically prove uncovered interest rate parity conditions seems to be related to the presence of risk premia on foreign currencies. Recent studies suggest that either consumption- or currency-return-based pricing factors explain the cross section of foreign currency portfolio returns. The contribution of this paper is twofold. It first shows that the return-based explanation applies to foreign currency portfolios built from the perspective of a Euro-Area investor. Second, the main results of this paper suggest that the decisive pricing factor, the so-called carry trade premium, mirrors business-cycle-related risks. Times of relatively large uninsured Euro-Area consumption growth risk are associated with an expected increase of the carry trade premium. Copyright Swiss Society for Financial Market Research 2010

Keywords: Consumption risk sharing; Foreign currency returns; Return predictability; Uncovered interest rate parity; F31; G10; G15 (search for similar items in EconPapers)
Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:kap:fmktpm:v:24:y:2010:i:1:p:49-65

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DOI: 10.1007/s11408-009-0119-9

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