Abstract

http://ssrn.com/abstract=2049809
 
 

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International Correlation Risk


Philippe Mueller


London School of Economics & Political Science (LSE) - Department of Finance

Andreas Stathopoulos


University of Southern California - Marshall School of Business

Andrea Vedolin


London School of Economics and Political Science

May 1, 2012


Abstract:     
We provide novel evidence of priced correlation risk in the foreign exchange market. Currencies that perform badly (well) during periods of high exchange rate correlation have high (low) average returns. We also show that high (low) interest rate currencies have high (low) correlation risk exposure, providing a risk-based justification for the carry trade. To address our empirical findings, we consider a general equilibrium model that incorporates preferences characterized by external habit formation and home bias. In our model, currencies which depreciate when conditional exchange rate correlation is high command high risk premia due to their adverse exposure to global risk aversion shocks.

Number of Pages in PDF File: 61

Keywords: Carry Trade, Correlation Risk, Habit, International Finance, Exchange Rates

JEL Classification: F31, G12, G13

working papers series


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Date posted: May 3, 2012 ; Last revised: January 7, 2013

Suggested Citation

Mueller, Philippe and Stathopoulos, Andreas and Vedolin, Andrea, International Correlation Risk (May 1, 2012). Available at SSRN: http://ssrn.com/abstract=2049809 or http://dx.doi.org/10.2139/ssrn.2049809

Contact Information

Philippe Mueller
London School of Economics & Political Science (LSE) - Department of Finance ( email )
Houghton Street
London, WC2A 2AE
United Kingdom
Andreas Stathopoulos
University of Southern California - Marshall School of Business ( email )
701 Exposition Blvd
Los Angeles, CA 90089
United States
Andrea Vedolin (Contact Author)
London School of Economics and Political Science ( email )
Department of Finance
Houghton Street
London, WC2A 2AE
United Kingdom
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