The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk

Lustig, Hanno N.; Verdelhan, Adrien

doi:10.2139/ssrn.647628

The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk

EFA 2005 Moscow Meetings

51 Pages Posted: 12 Jan 2005

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Adrien Verdelhan

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

There are 2 versions of this paper

Date Written: August 2006

Abstract

Aggregate consumption growth risk explains why low interest rate currencies do not appreciate as much as the interest rate differential and why high interest rate currencies do not depreciate as much as the interest rate differential. We sort foreign T-bills into portfolios based on the nominal interest rate differential with the US, and we test the Euler equation of a US investor who invests in these currency portfolios. US investors earn negative excess returns on low interest rate currency portfolios and positive excess returns on high interest rates currency portfolios. We find that low interest rate currencies provide US investors with a hedge against US aggregate consumption growth risk, because these currencies appreciate on average when US consumption growth is low, while high interest rate currencies depreciate when US consumption growth is low.

Keywords: Asset Pricing, Exchange Rates

JEL Classification: G12, F30

Suggested Citation: Suggested Citation

Lustig, Hanno N. and Verdelhan, Adrien, The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk (August 2006). EFA 2005 Moscow Meetings. Available at SSRN: https://ssrn.com/abstract=647628 or http://dx.doi.org/10.2139/ssrn.647628