Conditional Risk Premia in Currency Markets and Other Asset Classes

66 Pages Posted: 6 Mar 2013 Last revised: 10 May 2017

See all articles by Martin Lettau

Martin Lettau

University of California - Haas School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Matteo Maggiori

Harvard University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Michael Weber

University of Chicago - Finance

Multiple version iconThere are 3 versions of this paper

Date Written: September 27, 2013

Abstract

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

Lettau, Martin and Maggiori, Matteo and Weber, Michael, Conditional Risk Premia in Currency Markets and Other Asset Classes (September 27, 2013). Journal of Financial Economics (JFE), Vol. 114, No. 2, 2014. Available at SSRN: https://ssrn.com/abstract=2228967 or http://dx.doi.org/10.2139/ssrn.2228967

Martin Lettau (Contact Author)

University of California - Haas School of Business ( email )

Haas School of Business
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Berkeley, CA 94720
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HOME PAGE: http://faculty.haas.berkeley.edu/lettau/

Centre for Economic Policy Research (CEPR)

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United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Matteo Maggiori

Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Michael Weber

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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