Systematic Consumption Risk in Currency Returns

47 Pages Posted: 18 Jun 2013

See all articles by Mathias Hoffmann

Mathias Hoffmann

University of Zurich - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Rahel Studer-Suter

University of Zurich

Multiple version iconThere are 2 versions of this paper

Date Written: June 17, 2013

Abstract

We sort currencies by countries’ consumption growth over the past four quarters. Currency portfolios of countries experiencing consumption booms have higher Sharpe ratios than those of countries going through a consumption-based recession. A carry strategy that goes short in countries that are in a consumption bust and goes long in countries with a consumption boom yields consistently positive excess returns. This excess return compensates for the risk of high negative returns in worldwide downturns. Our consumption carry factor prices the cross section of portfolios of currencies sorted on various characteristics (consumption, interest rates) and also does well on the cross section of bilateral currency movements. Eventually, a habit formation model allows to interpret these results: sorting currencies on past consumption growth is akin to sorting countries on risk aversion, and low (high) risk aversion currencies depreciate (appreciate) in times of global turmoil.

Keywords: foreign exchange, carry trade returns, consumption risk, asset pricing

JEL Classification: E440, F310, F440, G120, G150

Suggested Citation

Hoffmann, Mathias and Studer-Suter, Rahel, Systematic Consumption Risk in Currency Returns (June 17, 2013). CESifo Working Paper Series No. 4273, Available at SSRN: https://ssrn.com/abstract=2280298

Mathias Hoffmann (Contact Author)

University of Zurich - Department of Economics ( email )

Zuerich, 8006
Switzerland

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Rahel Studer-Suter

University of Zurich ( email )

Department of Economics
International Trade & Finance Group
Zurich, 8032
Switzerland

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