Common Risk Factors in Currency Markets

Hanno Lustig, Nikolai Roussanov and Adrien Verdelhan ()

No 14082, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We identify a 'slope' factor in exchange rates. High interest rate currencies load more on this slope factor than low interest rate currencies. As a result, this factor can account for most of the cross-sectional variation in average excess returns between high and low interest rate currencies. A standard, no-arbitrage model of interest rates with two factors - a country- specific factor and a global factor - can replicate these findings, provided there is sufficient heterogeneity in exposure to the global risk factor. We show that our slope factor is a global risk factor. By investing in high interest rate currencies and borrowing in low interest rate currencies, US investors load up on global risk, particularly during bad times.

JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2008-06
New Economics Papers: this item is included in nep-ifn and nep-rmg
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Citations: View citations in EconPapers (35)

Published as Hanno Lustig & Nikolai Roussanov & Adrien Verdelhan, 2011. "Common Risk Factors in Currency Markets," Review of Financial Studies, vol 24(11), pages 3731-3777.

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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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