Salvaging the C-CAPM: Currency Carry Trade Risk Premia and Conditioning Information
35 Pages Posted: 14 Sep 2011
Date Written: September 14, 2011
We use a standard consumption-based asset pricing model incorporating conditioning information to explain the risk-return profile of currency carry trade portfolios. We use a scaled stochastic discount factor instead of scaled or managed portfolio returns as in previous work. Our conditioning variable is a forward-looking measure of net foreign assets. It arises from an intertemporal budget constraint and has predictive power for exchange rates. We find that our conditional consumption-CAPM is able to price a large part of the variation in cross-section of carry trade portfolios using cross-sectional as well as time series regression-based tests. Taken together, our results imply that the consumption-based models do still have a role to play in explaining excess returns on carry trade strategies.
Keywords: Consumption CAPM, Fama-MacBeth Regressions, Net Foreign Assets, Conditioning Information, Conditional Asset Pricing Models
JEL Classification: G0, G10, G12
Suggested Citation: Suggested Citation