Equity Tail Risk and Currency Risk Premiums
69 Pages Posted: 17 Jun 2019 Last revised: 11 May 2021
Date Written: November 19, 2019
We find that an option-based equity tail risk factor is priced in the cross section of currency returns; more exposed currencies offer a low risk premium because they hedge against equity tail risk. A portfolio that buys currencies with high equity tail beta and shorts those with low beta extracts the global component in the tail factor. The estimated price of risk of this novel global factor is consistently negative in currency carry and momentum portfolios, and in portfolios of other asset classes, suggesting that excess returns of these strategies can be partially understood as compensations for global tail risk.
Keywords: Global tail risk; Option-implied equity tail risk; Currency returns; Carry trade; Currency momentum
JEL Classification: G12, G15, F31
Suggested Citation: Suggested Citation