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Uncertainty, currency excess returns, and risk reversals

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  • Husted, Lucas
  • Rogers, John
  • Sun, Bo

Abstract

In this paper we provide strong evidence that heightened uncertainty in the U.S. real economy or financial markets significantly raises excess returns to the currency carry trade. We posit that this works through the influence of uncertainty on global investors’ risk preferences. Macro and financial uncertainty also lower foreign exchange risk reversals, an effect that is particularly strong for high interest rate portfolios. Our results are consistent with the idea that an increase in uncertainty regarding the U.S. economy or financial markets increases investors’ risk aversion, which in turn drives up the expected returns and the cost of protection against crash risk in the FX market.

Suggested Citation

  • Husted, Lucas & Rogers, John & Sun, Bo, 2018. "Uncertainty, currency excess returns, and risk reversals," Journal of International Money and Finance, Elsevier, vol. 88(C), pages 228-241.
  • Handle: RePEc:eee:jimfin:v:88:y:2018:i:c:p:228-241
    DOI: 10.1016/j.jimonfin.2017.07.011
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    1. repec:eee:mulfin:v:49:y:2019:i:c:p:1-19 is not listed on IDEAS
    2. repec:eee:jimfin:v:88:y:2018:i:c:p:212-227 is not listed on IDEAS
    3. Berg, Kimberly A. & Mark, Nelson C., 2018. "Measures of global uncertainty and carry-trade excess returns," Journal of International Money and Finance, Elsevier, vol. 88(C), pages 212-227.
    4. repec:gam:jsusta:v:11:y:2019:i:12:p:3240-:d:239134 is not listed on IDEAS

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    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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