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Systematic consumption risk in currency returns

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  • Mathias Hoffmann
  • Rahel Suter

Abstract

We sort currencies into portfolios by countries’ consumption growth over the past year. The excess return of the highest-consumption-growth currency portfolio over the portfolio of lowest-consumption-growth currencies is positive on average, compensating investors for large negative returns during world-wide downturns. This return—our consumption carry factor—prices the cross-section of portfolio-sorted and of bilateral currency returns. Our results rest on minimal theoretical restrictions but can be interpreted in a habit formation model: sorting currencies on past consumption growth approximates sorting countries based on risk aversion and low (high) risk-aversion currencies depreciate (appreciate) in times of global turmoil.

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Bibliographic Info

Paper provided by Department of Economics - University of Zurich in its series ECON - Working Papers with number 124.

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Date of creation: Jun 2013
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Handle: RePEc:zur:econwp:124

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Keywords: Foreign exchange; uncovered interest parity; carry trade returns; consumption risk; asset pricing; habit model;

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  1. Hanno Lustig & Adrien Verdelhan, 2007. "The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk," American Economic Review, American Economic Association, vol. 97(1), pages 89-117, March.
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  15. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
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Cited by:
  1. Victoria Atanasov, 2014. "Common Risk Factors in Equity Markets," Tinbergen Institute Discussion Papers 14-070/IV, Tinbergen Institute.

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