Conditional Risk Premia in Currency Markets and Other Asset Classes
66 Pages Posted: 6 Mar 2013 Last revised: 10 May 2017
Date Written: September 27, 2013
The downside risk CAPM (DR-CAPM) can price the cross section of currency returns. The market-beta differential between high and low interest rate currencies is higher conditional on bad market returns, when the market price of risk is also high, than it is conditional on good market returns. Correctly accounting for this variation is crucial for the empirical performance of the model. The DR-CAPM can jointly explain the cross section of equity, commodity, sovereign bond and currency returns, thus offering a unified risk view of these asset classes. In contrast, popular models that have been developed for a specific asset class fail to jointly price other asset classes.
Keywords: Carry Trade, Currency Returns, Downside Risk, Exchange Rates, UIP, Conditional risk premia, Cross Section of Equities and Commodities
JEL Classification: F31, F34, G11, G15
Suggested Citation: Suggested Citation