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Uncertainty, Curreny Exess Returns, and Risk Reversals

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  • Lucas F. Husted
  • John H. Rogers
  • Bo Sun

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

  • Lucas F. Husted & John H. Rogers & Bo Sun, 2017. "Uncertainty, Curreny Exess Returns, and Risk Reversals," International Finance Discussion Papers 1196, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:1196
    DOI: 10.17016/IFDP.2017.1196
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    JEL classification:

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

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