The Forward Premium is Still a Puzzle
36 Pages Posted: 27 Jun 2007 Last revised: 26 Jul 2007
Date Written: May 2007
Lustig and Verdelhan (2007) argue that the excess returns to borrowing US dollars and lending in foreign currency "compensate US investors for taking on more US consumption growth risk," yet the stochastic discount factor corresponding to their benchmark model is approximately uncorrelated with the returns they study. Hence, one cannot reject the null hypothesis that their model explains none of the cross-sectional variation of the expected returns. Given this finding, and other evidence, I argue that the forward premium puzzle remains a puzzle.
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