Equity Tail Risk and Currency Risk Premiums

69 Pages Posted: 17 Jun 2019 Last revised: 11 May 2021

See all articles by Zhenzhen Fan

Zhenzhen Fan

University of Manitoba - Department of Accounting and Finance

Juan M. Londono

Board of Governors of the Federal Reserve System

Xiao Xiao

University of Amsterdam - Amsterdam Business School

Date Written: November 19, 2019

Abstract

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

Fan, Zhenzhen and Londono-Yarce, Juan-Miguel and Xiao, Xiao, Equity Tail Risk and Currency Risk Premiums (November 19, 2019). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3399980 or http://dx.doi.org/10.2139/ssrn.3399980

Zhenzhen Fan

University of Manitoba - Department of Accounting and Finance ( email )

Faculty of Management
Winnipeg, MB R3T 5V4
Canada

Juan-Miguel Londono-Yarce

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Xiao Xiao (Contact Author)

University of Amsterdam - Amsterdam Business School ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

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