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Idiosyncratic consumption risk and predictability of the carry trade premium: Euro-Area evidence

  • Thomas Nitschka

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    The failure to empirically prove uncovered interest rate parity conditions seems to be related to the presence of risk premia on foreign currencies. Recent studies suggest that either consumption- or currency-return-based pricing factors explain the cross section of foreign currency portfolio returns. The contribution of this paper is twofold. It first shows that the return-based explanation applies to foreign currency portfolios built from the perspective of a Euro-Area investor. Second, the main results of this paper suggest that the decisive pricing factor, the so-called carry trade premium, mirrors business-cycle-related risks. Times of relatively large uninsured Euro-Area consumption growth risk are associated with an expected increase of the carry trade premium. Copyright Swiss Society for Financial Market Research 2010

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    File URL: http://hdl.handle.net/10.1007/s11408-009-0119-9
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    Article provided by Springer in its journal Financial Markets and Portfolio Management.

    Volume (Year): 24 (2010)
    Issue (Month): 1 (March)
    Pages: 49-65

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    Handle: RePEc:kap:fmktpm:v:24:y:2010:i:1:p:49-65
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    1. Hanno Lustig & Stijn Van Nieuwerburgh, 2010. "How Much Does Household Collateral Constrain Regional Risk Sharing?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(2), pages 265-294, April.
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    3. Thomas Nitschka, 2010. "International Evidence for Return Predictability and the Implications for Long-Run Covariation of the G7 Stock Markets," German Economic Review, Verein für Socialpolitik, vol. 11, pages 527-544, November.
    4. Paul Söderlind, 2006. "C-CAPM Refinements and the Cross-Section of Returns," University of St. Gallen Department of Economics working paper series 2006 2006-07, Department of Economics, University of St. Gallen.
    5. Hanno Lustig & Adrien Verdelhan, 2006. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," Boston University - Department of Economics - Working Papers Series WP2006-045, Boston University - Department of Economics.
    6. Christoph Sax, 2006. "Interest Rates and Exchange Rate Movements: Analyzing Short-term Investments in Long-term Bonds," Financial Markets and Portfolio Management, Springer, vol. 20(2), pages 205-220, June.
    7. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
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