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

95 Pages Posted: 15 Jun 2019 Last revised: 18 May 2020

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 15, 2020

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 a significantly positive price of risk of 2.52% per year; beta with global real-rate news is "good" because of the negative price of risk. The price of risk-premium-beta risk is countercyclical, whereas the price of the real-rate-beta risk is procyclical. Most prevailing currency trading strategies have either excessive "bad beta" or too little "good beta," thus fail 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 15, 2020). 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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