Expected Currency Returns and Volatility Risk Premia

38 Pages Posted: 14 Jul 2016 Last revised: 20 Jun 2017

Date Written: June 10, 2016

Abstract

This paper addresses the predictive ability of currency volatility risk premium - the difference between an implied and a realized volatility - over US dollar exchange rates using a time series perspective. The intuition is that, when risk aversion sentiment increases, the market quickly discounts the currency, and latter this discount is accrued, leading to a future currency appreciation. Based on two different samples with a diversified set of 32 currencies, I document a positive relationship between currency volatility risk premium and future currency returns. Results remain robust even after controlling for traditional fundamental predictors like Purchase Power Parity and interest rate differential.

Keywords: Currency return predictability, Volatility risk premium

JEL Classification: G12, G15, G17, F31, F37

Suggested Citation

Ornelas, Jose Renato Haas, Expected Currency Returns and Volatility Risk Premia (June 10, 2016). Available at SSRN: https://ssrn.com/abstract=2809141 or http://dx.doi.org/10.2139/ssrn.2809141

Jose Renato Haas Ornelas (Contact Author)

Banco Central do Brasil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distrito Federal 70074-900
Brazil

HOME PAGE: http://www.bcb.gov.br

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