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Can the Consumption Capital Asset Pricing Model Account for Traders' Expected Currency Returns?

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  • Josh R. Stillwagon

Abstract

This study uses survey data on traders' exchange rate forecasts to test whether their expected excess returns are related to the covariance between the exchange rate and consumption; as predicted by the consumption capital asset pricing model (CCAPM). The covariance is measured through the novel use of rolling windows of the realized covariance (both forward and backward looking) and testing is conducted with the cointegrated VAR. The model is able to account for expected returns with more plausible degrees of risk aversion, but only when using sufficiently long, backward-looking measures of the covariance. This suggests that market participants assess risk, in part, based upon the pro-cyclicality of returns, and infer it from experience in the recent past. There is also evidence that inclusion of the real exchange rate improves the plausibility of the estimates and the model fit.

Suggested Citation

  • Josh R. Stillwagon, 2015. "Can the Consumption Capital Asset Pricing Model Account for Traders' Expected Currency Returns?," Review of International Economics, Wiley Blackwell, vol. 23(5), pages 1044-1069, November.
    • Handle: RePEc:bla:reviec:v:23:y:2015:i:5:p:1044-1069
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    File URL: http://hdl.handle.net/10.1111/roie.12195
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    Cited by:

    1. Stillwagon, Josh R., 2016. "Non-linear exchange rate relationships: An automated model selection approach with indicator saturation," The North American Journal of Economics and Finance, Elsevier, vol. 37(C), pages 84-109.
    2. Cavusoglu, Nevin & Goldberg, Michael D. & Stillwagon, Josh, 2021. "Currency returns and downside risk: Debt, volatility, and the gap from benchmark values," Journal of Macroeconomics, Elsevier, vol. 68(C).
    3. Nevin Cavusoglu & Michael D. Goldberg & Joshua Stillwagon, 2019. "New Evidence on the Portfolio Balance Approach to Currency Returns," Working Papers Series 89, Institute for New Economic Thinking.

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