Global Variance Risk Premium and Forex Return Predictability

Arash Aloosh

MPRA Paper from University Library of Munich, Germany

Abstract: In a long-run risk model with stochastic volatility and frictionless markets, I express expected forex returns as a function of consumption growth variances and stock variance risk premiums (VRPs)—the difference between the risk-neutral and statistical expectations of market return variation. This provides a motivation for using the forward-looking information available in stock market volatility indices to predict forex returns. Empirically, I find that stock VRPs predict forex returns at a one-month horizon, both in-sample and out-of-sample. Moreover, compared to two major currency carry predictors, global VRP has more predictive power for currency carry trade returns, bilateral forex returns, and excess equity return differentials.

Keywords: Global Variance Risk Premium; Excess Foreign Exchange (Forex) Return; Frictionless Markets; Predictability. (search for similar items in EconPapers)
JEL-codes: F31 F37 G15 (search for similar items in EconPapers)
Date: 2014-11-19
New Economics Papers: this item is included in nep-fmk, nep-for, nep-rmg and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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