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Switching Risk Off: FX Correlations and Risk Premia

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  • Beber, Alessandro
  • Brandt, Michael
  • Cen, Jason

Abstract

Risk-off refers to a change in risk preferences and the associated portfolio rebalancing. We identify these episodes using the switch to a polarized correlation regime of foreign-exchange returns. These risk-off transitions are relatively infrequent but noticeably increasing over time, are persistent and associated with geopolitical events, and seem unrelated to changes in macroeconomic fundamentals and to volatility or average correlation shocks. Risk-off switches have very significant effects on the returns of a large number of asset classes and trading strategies, with risky and safe asset returns being penalized and favored, respectively. This evidence is consistent with a price pressure story induced by portfolio rebalancing, as we document that risk-off transitions are associated with significant changes in the positions of professional investors across different futures markets.

Suggested Citation

  • Beber, Alessandro & Brandt, Michael & Cen, Jason, 2014. "Switching Risk Off: FX Correlations and Risk Premia," CEPR Discussion Papers 10214, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:10214
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    Cited by:

    1. Tim A Kroencke & Maik Schmeling & Andreas Schrimpf, 2015. "Global Asset Allocation Shifts," BIS Working Papers 497, Bank for International Settlements.
    2. Hasler, Nicole, 2016. "US International Equity Investment and Economic Fundamentals," VfS Annual Conference 2016 (Augsburg): Demographic Change 145840, Verein für Socialpolitik / German Economic Association.
    3. Turtle, H.J. & Wang, Kainan, 2016. "The benefits of improved covariance estimation," Journal of Empirical Finance, Elsevier, vol. 37(C), pages 233-246.

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    More about this item

    Keywords

    currency risk premia; FX correlation; risk-off;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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