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Systematic Consumption Risk in Currency Returns

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  • Mathias Hoffmann
  • Rahel Suter

Abstract

We sort currencies by countries’ consumption growth over the past four quarters. Currency portfolios of countries experiencing consumption booms have higher Sharpe ratios than those of countries going through a consumption-based recession. A carry strategy that goes short in countries that are in a consumption bust and goes long in countries with a consumption boom yields consistently positive excess returns. This excess return compensates for the risk of high negative returns in worldwide downturns. Our consumption carry factor prices the cross section of portfolios of currencies sorted on various characteristics (consumption, interest rates) and also does well on the cross section of bilateral currency movements. Eventually, a habit formation model allows to interpret these results: sorting currencies on past consumption growth is akin to sorting countries on risk aversion, and low (high) risk aversion currencies depreciate (appreciate) in times of global turmoil.

Suggested Citation

  • Mathias Hoffmann & Rahel Suter, 2013. "Systematic Consumption Risk in Currency Returns," CESifo Working Paper Series 4273, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_4273
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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.
    2. repec:eee:jbfina:v:84:y:2017:i:c:p:88-106 is not listed on IDEAS
    3. Alexandra Janssen & Rahel Studer, 2014. "The Swiss franc's honeymoon," ECON - Working Papers 170, Department of Economics - University of Zurich, revised Jan 2017.

    More about this item

    Keywords

    foreign exchange; carry trade returns; consumption risk; asset pricing;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • 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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