Countercyclical Currency Risk Premia

58 Pages Posted: 26 Jan 2010 Last revised: 7 Nov 2014

Hanno N. Lustig

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

Nikolai L. Roussanov

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Adrien Verdelhan

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

Multiple version iconThere are 2 versions of this paper

Date Written: January 13, 2012

Abstract

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.

Keywords: Exchange Rates, Forecasting, Risk Premia

JEL Classification: G12, G15, F31

Suggested Citation

Lustig, Hanno N. and Roussanov, Nikolai L. and Verdelhan, Adrien, Countercyclical Currency Risk Premia (January 13, 2012). Journal of Financial Economics (JFE), Forthcoming; AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1541230 or http://dx.doi.org/10.2139/ssrn.1541230

Hanno N. Lustig

Stanford Graduate School of Business ( email )

Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Nikolai L. Roussanov

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Adrien Verdelhan (Contact Author)

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

77 Massachusetts Ave.
E62-416
Cambridge, MA 02142
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Paper statistics

Downloads
1,597
Rank
7,828
Abstract Views
7,227