Abstract

http://ssrn.com/abstract=1139447
 
 

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Common Risk Factors in Currency Markets


Hanno N. Lustig


UCLA - Anderson School of Management; National Bureau of Economic Research (NBER)

Nikolai L. Roussanov


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

Adrien Verdelhan


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

May 3, 2011

Review of Financial Studies ( 2011), 24(11)
.

Abstract:     
We identify a ‘slope’ factor in exchange rates. High interest rate currencies load more on this slope factor than low interest rate currencies. This factor accounts 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 global or common innovations. We show that our slope factor identifies these common shocks, and we provide empirical evidence that it is related to changes in global equity market volatility. By investing in high interest rate currencies and borrowing in low interest rate currencies, US investors load up on global risk.

Number of Pages in PDF File: 74

Keywords: Carry Trade, Currency Risk

JEL Classification: G12, G15, F31

Accepted Paper Series


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Date posted: June 1, 2008 ; Last revised: August 27, 2012

Suggested Citation

Lustig, Hanno N. and Roussanov, Nikolai L. and Verdelhan, Adrien, Common Risk Factors in Currency Markets (May 3, 2011). Review of Financial Studies ( 2011), 24(11); .. Available at SSRN: http://ssrn.com/abstract=1139447 or http://dx.doi.org/10.2139/ssrn.1139447

Contact Information

Hanno N. Lustig (Contact Author)
UCLA - Anderson School of Management ( email )
405 Hilgard Avenue
Box 951361
Los Angeles, CA 90095
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Nikolai L. Roussanov
University of Pennsylvania - The Wharton School ( email )
3641 Locust Walk
Philadelphia, PA 19104-6365
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Adrien Verdelhan
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
77 Massachusetts Ave.
E62-416
Cambridge, MA 02142
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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