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

52 Pages Posted: 8 Aug 2012  

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)

Date Written: February 2005

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. As a result, the risk premia predicted by the Consumption-CAPM match the average excess returns on these currency portfolios.

Suggested Citation

Lustig, Hanno N. and Verdelhan, Adrien, The Cross-Section of Currency Risk Premia and Us Consumption Growth Risk (February 2005). NBER Working Paper No. w11104. Available at SSRN: https://ssrn.com/abstract=663486

Hanno N. Lustig (Contact Author)

Stanford Graduate School of Business ( email )

Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Adrien Verdelhan

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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