Expected Currency Returns and Volatility Risk Premia
38 Pages Posted: 14 Jul 2016 Last revised: 20 Jun 2017
Date Written: June 10, 2016
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
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