Option-Implied Currency Risk Premia

Jurek, Jakub W.; Xu, Zhikai

doi:10.2139/ssrn.2338585

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Option-Implied Currency Risk Premia

79 Pages Posted: 13 Oct 2013 Last revised: 17 Oct 2014

See all articles by Jakub W. Jurek

Jakub W. Jurek

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Zhikai Xu

AQR Capital Management, LLC

Date Written: October 15, 2014

Abstract

We obtain ex ante estimates of risk premia for G10 currency pairs using cross-sectional data on exchange rate options. Option prices are well-matched by a non-Gaussian, two-factor model, consistent with evidence from realized currency returns. We find that option-implied currency risk premia provide an unbiased forecast of monthly currency excess returns, and achieve cross-sectional forecasting R^2s of up to 44%. Despite prominent non-normalities in option data, less than 20% of the model HML-FX risk premium, or roughly 70bps per annum, is due to the asymmetries and higher-moments of global risks.

Keywords: risk premia, currency carry trade, disaster risk, exchange rate options

JEL Classification: F31, G12

Suggested Citation: Suggested Citation

Jurek, Jakub W. and Xu, Zhikai, Option-Implied Currency Risk Premia (October 15, 2014). Available at SSRN: https://ssrn.com/abstract=2338585 or http://dx.doi.org/10.2139/ssrn.2338585