The Cross-Section of Currency Volatility Premia
96 Pages Posted: 13 Jan 2017 Last revised: 20 Oct 2018
Date Written: October 15, 2018
We identify a global risk factor in the cross-section of implied volatility returns in currency markets. A zero-cost strategy that buys forward volatility agreements with downward sloping implied volatility curves and sells those with upward slopes – volatility carry strategy – generates significant excess returns. The covariation with volatility carry returns fully explains the cross-sectional variation of our slope-sorted portfolios. The lower the slope, the more the forward volatility agreement is exposed to volatility carry risk. We provide evidence that exposure to volatility carry risk is related to squared differences in growth between the US and the local economy.
Keywords: Currency Volatility Risk Premia, Forward Volatility Agreement, Foreign Exchange Volatility, Term Structure
JEL Classification: F31, F37, G01, G11, G12, G13, G15
Suggested Citation: Suggested Citation