A 'Bad Beta, Good Beta' Anatomy of Currency Risk Premiums and Trading Strategies

115 Pages Posted: 15 Jun 2019 Last revised: 16 Jun 2023

See all articles by I-Hsuan Ethan Chiang

I-Hsuan Ethan Chiang

University of North Carolina (UNC) at Charlotte

Xi Nancy Mo

University of North Carolina (UNC) at Charlotte, The Belk College of Business Administration, Finance

Date Written: June 16, 2023

Abstract

The paper introduces a novel two-beta currency pricing model to address the "flat dollar beta vs. premium" puzzle by decomposing the conventional dollar factor beta into a beta with risk-premium news and a beta with real-interest-rate news. These betas capture distinct features of currency returns and explain cross-sectional variations in currency risk premiums. The risk-premium beta is
associated with an unconditionally positive price of risk, while the real-rate beta has an unconditionally negative price of risk due to precautionary savings. The prices of these beta risks exhibit conditional variations tied to economic conditions. Furthermore, the model explains the abnormal performance of various currency trading strategies.

Keywords: currency risk premium, real exchange rate, variance decomposition, present value decomposition, multifactor model, carry trade

JEL Classification: F31, G12, G15

Suggested Citation

Chiang, I-Hsuan Ethan and Mo, Xi, A 'Bad Beta, Good Beta' Anatomy of Currency Risk Premiums and Trading Strategies (June 16, 2023). Available at SSRN: https://ssrn.com/abstract=3393265 or http://dx.doi.org/10.2139/ssrn.3393265

I-Hsuan Ethan Chiang (Contact Author)

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

HOME PAGE: http://go.uncc.edu/chiang

Xi Mo

University of North Carolina (UNC) at Charlotte, The Belk College of Business Administration, Finance ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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