Variance Risk Premiums and the Forward Premium Puzzle

67 Pages Posted: 22 Aug 2012 Last revised: 22 Jun 2016

See all articles by Juan M. Londono

Juan M. Londono

Federal Reserve Board of Governors

Hao Zhou

Tsinghua University - PBC School of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: June 17, 2016

Abstract

We provide new empirical evidence that world currency and U.S. stock variance risk premiums have nonredundant and significant predictive power for the appreciation rates of twenty-two currencies with respect to the U.S. dollar, especially at the four-month and one-month horizons, respectively. The heterogeneous exposures of currencies to the currency variance risk premium are systematically rising along the line of inflation risk. We rationalize these findings in a consumption-based asset pricing model, with local consumption uncertainty and global inflation uncertainty characterized, respectively, by the stock and currency variance risk premiums.

Keywords: Currency return predictability, currency and stock variance risk premiums, forward premium puzzle, local consumption uncertainty, global inflation uncertainty.

JEL Classification: G12, G15, F31

Suggested Citation

Londono-Yarce, Juan-Miguel and Zhou, Hao, Variance Risk Premiums and the Forward Premium Puzzle (June 17, 2016). Available at SSRN: https://ssrn.com/abstract=2133569 or http://dx.doi.org/10.2139/ssrn.2133569

Juan-Miguel Londono-Yarce (Contact Author)

Federal Reserve Board of Governors ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

Hao Zhou

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China
86-10-62790655 (Phone)

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