Countercyclical Currency Risk Premia

58 Pages Posted: 26 Jan 2010 Last revised: 10 Sep 2020

See all articles by Hanno N. Lustig

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Nikolai L. Roussanov

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Adrien Verdelhan

National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Sloan School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: January 13, 2012

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 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.

Keywords: Exchange Rates, Forecasting, Risk Premia

JEL Classification: G12, G15, F31

Suggested Citation

Lustig, Hanno N. and Roussanov, Nikolai L. and Verdelhan, Adrien and Verdelhan, Adrien, Countercyclical Currency Risk Premia (January 13, 2012). Journal of Financial Economics (JFE), Forthcoming, AFA 2011 Denver Meetings Paper, Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=1541230 or http://dx.doi.org/10.2139/ssrn.1541230

Hanno N. Lustig

Stanford Graduate School of Business ( email )

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Nikolai L. Roussanov

University of Pennsylvania - The Wharton School ( email )

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Adrien Verdelhan (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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National Bureau of Economic Research (NBER) ( email )

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