A 'Bad Beta, Good Beta' Anatomy of Currency Risk Premiums and Trading Strategies

92 Pages Posted: 15 Jun 2019

See all articles by I-Hsuan Ethan Chiang

I-Hsuan Ethan Chiang

University of North Carolina (UNC) at Charlotte

Xi Nancy Mo

University of North Carolina (UNC) at Charlotte, The Belk College of Business Administration, Finance

Date Written: May 23, 2019

Abstract

We test a two-beta currency pricing model that features betas with risk-premium news and real-rate news of the currency market. Unconditionally, beta with currency market risk-premium news is “bad” because of significantly positive price of risk (2.52% per year); beta with global real-rate news is “good” due to nearly zero or negative price of risk. The price of risk-premium beta risk is counter-cyclical, while the price of the real-rate beta risk is pro-cyclical. Most prevailing currency trading strategies either have excessive “bad beta” or too little “good beta,” failing to deliver abnormal performance. Our empirical results can be delivered by a no-arbitrage model with precautionary savings and a pricing kernel characterized by two separate global shocks.

Keywords: currency risk premium, real exchange rate, variance decomposition, present value decomposition, multifactor model, carry trade

JEL Classification: F31, G12, G15

Suggested Citation

Chiang, I-Hsuan Ethan and Mo, Xi, A 'Bad Beta, Good Beta' Anatomy of Currency Risk Premiums and Trading Strategies (May 23, 2019). Available at SSRN: https://ssrn.com/abstract=3393265 or http://dx.doi.org/10.2139/ssrn.3393265

I-Hsuan Ethan Chiang (Contact Author)

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

HOME PAGE: http://go.uncc.edu/chiang

Xi Mo

University of North Carolina (UNC) at Charlotte, The Belk College of Business Administration, Finance ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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