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Conditional risk premia in currency markets and other asset classes

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  • Lettau, Martin
  • Maggiori, Matteo
  • Weber, Michael

Abstract

The downside risk capital asset pricing model (DR-CAPM) can price the cross section of currency returns. The market-beta differential between high and low interest rate currencies is higher conditional on bad market returns, when the market price of risk is also high, than it is conditional on good market returns. Correctly accounting for this variation is crucial for the empirical performance of the model. The DR-CAPM can jointly rationalize the cross section of equity, equity index options, commodity, sovereign bond and currency returns, thus offering a unified risk view of these asset classes. In contrast, popular models that have been developed for a specific asset class fail to jointly price other asset classes.

Suggested Citation

  • Lettau, Martin & Maggiori, Matteo & Weber, Michael, 2014. "Conditional risk premia in currency markets and other asset classes," Journal of Financial Economics, Elsevier, vol. 114(2), pages 197-225.
  • Handle: RePEc:eee:jfinec:v:114:y:2014:i:2:p:197-225 DOI: 10.1016/j.jfineco.2014.07.001
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    More about this item

    Keywords

    Carry trade; Commodity basis; Downside risk; Equity cross section;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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