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

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Author Info
Hanno Lustig
Adrien Verdelhan

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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. Domestic investors earn negative excess returns on low interest rate currency portfolios and positive excess returns on high interest rate currency portfolios. Because high interest rate currencies depreciate on average when domestic consumption growth is low and low interest rate currencies appreciate under the same conditions, low interest rate currencies provide domestic investors with a hedge against domestic aggregate consumption growth risk. (JEL E21, E43, F31, G11)

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 97 (2007)
Issue (Month): 1 (March)
Pages: 89-117
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Handle: RePEc:aea:aecrev:v:97:y:2007:i:1:p:89-117

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  2. Froot, Kenneth A & Thaler, Richard H, 1990. "Foreign Exchange," Journal of Economic Perspectives, American Economic Association, vol. 4(3), pages 179-92, Summer. [Downloadable!] (restricted)
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  22. Sergei Sarkissian, 2003. "Incomplete Consumption Risk Sharing and Currency Risk Premiums," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 16(3), pages 983-1005, July. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Emmanuel Farhi & Xavier Gabaix, 2008. "Rare Disasters and Exchange Rates," NBER Working Papers 13805, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Hanno Lustig & Nikolai Roussanov & Adrien Verdelhan, 2008. "Common Risk Factors in Currency Markets," NBER Working Papers 14082, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Dennis Quinn & Joachim Voth, 2006. "Free Flows, Limited Diversification: Explaining the Fall and Rise of Stock Market Correlations, 1890-2001," Economics Working Papers 1119, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2008. [Downloadable!]
  4. Adrien Verdelhan, 2006. "A Habit-Based Explanation of the Exchange Rate Risk Premium," Boston University - Department of Economics - Macroeconomics Working Papers Series WP2006-047, Boston University - Department of Economics. [Downloadable!]
  5. Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, 2008. "Time-varying risk, interest rates, and exchange rates in general equilibrium," Staff Report 371, Federal Reserve Bank of Minneapolis. [Downloadable!]
    Other versions:
  6. Pierre Perron† & Tatsuma Wada, 2005. "Let’s Take a Break: Trends and Cycles in US Real GDP?," Boston University - Department of Economics - Working Papers Series WP2005-031, Boston University - Department of Economics, revised Oct 2005. [Downloadable!]
  7. Hanno Lustig & Adrien Verdelhan, 2008. "Note on The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," NBER Working Papers 13812, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Craig Burnside, 2007. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk: A Comment," NBER Working Papers 13129, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. A. Craig Burnside, 2007. "Empirical Asset Pricing and Statistical Power in the Presence of Weak Risk Factors," NBER Working Papers 13357, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Daniel Kohler, 2007. "Carry Trades: Betting Against Safe Haven," University of St. Gallen Department of Economics working paper series 2007 2007-12, Department of Economics, University of St. Gallen. [Downloadable!]
  11. Hanno Lustig, 2005. "Investing in Foreign Currency is like Betting on your Intertemporal Marginal Rate of Substitution (joint with Adrien Verdelhan, BU, forthcoming in Papers and Proceedings JEEA)," UCLA Economics Online Papers 368, UCLA Department of Economics. [Downloadable!]
  12. John Y. Campbell & Karine Serfaty-de Medeiros & Luis M. Viceira, 2007. "Global Currency Hedging," NBER Working Papers 13088, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Douglas Steigerwald & Jack Erb, 2007. "Accurately Sized Test Statistics with Misspecified Conditional Homoskedasticity," University of California at Santa Barbara, Economics Working Paper Series 09-07, Department of Economics, UC Santa Barbara. [Downloadable!]
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