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The Cross-Section Of Foreign Currency Risk Premia And Consumption Growth Risk

  • Adrien Verdelhan

    ()

    (Department of Economics, Boston University)

  • Hanno Lustig

    (UCLA/ NBER)

Aggregate consumption growth risk explains why low interest rate currencies do not appreciate as much as the interest rate di®erential and why high interest rate currencies do not depreciate as much as the interest rate di®erential. We sort foreign currency returns into portfolios based on foreign interest rates, and we test the Euler equation of a domestic investor who invests in these currency portfolios. We ¯nd that domestic investors earn negative excess returns on low interest rate currency portfolios and positive excess returns on high interest rate currency portfolios. Because high interest rate currencies depreciate on average when domestic consumption growth is low and low interest rate currencies do not under the same conditions, low interest rate currencies provide domestic investors with a hedge against domestic aggregate consumption growth risk.

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Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - Working Papers Series with number WP2005-019.

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Length: 51 pages
Date of creation: Jun 2005
Date of revision:
Handle: RePEc:bos:wpaper:wp2005-019
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Web page: http://www.bu.edu/econ/

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