Countercyclical Currency Risk Premia
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)
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
January 13, 2012
AFA 2011 Denver Meetings Paper
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.
Number of Pages in PDF File: 58
Keywords: Exchange Rates, Forecasting, Risk Premia
JEL Classification: G12, G15, F31working papers series
Date posted: March 18, 2010 ; Last revised: January 14, 2012
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