The Cross-Section of Currency Risk Premia and Us Consumption Growth Risk

52 Pages Posted: 8 Aug 2012 Last revised: 5 Nov 2022

See all articles by Hanno N. Lustig

Hanno N. Lustig

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

Adrien Verdelhan

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

Date Written: February 2005

Abstract

Aggregate consumption growth risk explains why low interest rate currencies do not appreciate as much as the interest rate differential and why high interest rate currencies do not depreciate as much as the interest rate differential. We sort foreign T-bills into portfolios based on the nominal interest rate differential with the US, and we test the Euler equation of a US investor who invests in these currency portfolios. US investors earn negative excess returns on low interest rate currency portfolios and positive excess returns on high interest rates currency portfolios. We find that low interest rate currencies provide US investors with a hedge against US aggregate consumption growth risk, because these currencies appreciate on average when US consumption growth is low, while high interest rate currencies depreciate when US consumption growth is low. As a result, the risk premia predicted by the Consumption-CAPM match the average excess returns on these currency portfolios.

Suggested Citation

Lustig, Hanno N. and Verdelhan, Adrien and Verdelhan, Adrien, The Cross-Section of Currency Risk Premia and Us Consumption Growth Risk (February 2005). NBER Working Paper No. w11104, Available at SSRN: https://ssrn.com/abstract=663486

Hanno N. Lustig (Contact Author)

Stanford Graduate School of Business ( email )

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National Bureau of Economic Research (NBER)

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Adrien Verdelhan

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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United States

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

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