Countercyclical Currency Risk Premia

Hanno Lustig, Nikolai Roussanov and Adrien Verdelhan ()

No 16427, NBER Working Papers from National Bureau of Economic Research, Inc

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 counter-cyclical 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 world-wide risk is the key driver of predictability.

JEL-codes: F3 F31 G12 (search for similar items in EconPapers)
Date: 2010-09
Note: AP IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (27)

Published as Lustig, Hanno & Roussanov, Nikolai & Verdelhan, Adrien, 2014. "Countercyclical currency risk premia," Journal of Financial Economics, Elsevier, vol. 111(3), pages 527-553.

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Journal Article: Countercyclical currency risk premia (2014)
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