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The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk: A Reply

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  • Hanno Lustig
  • Adrien Verdelhan

Abstract

The U.S. consumption growth beta of an investment strategy that goes long in high interest rate currencies and short in low interest rate currencies is large and significant. The price of consumption risk is significantly different from zero, even after accounting for the sampling uncertainty introduced by the estimation of the consumption betas. The constant in the regression of average returns on consumption betas is not significant. In addition, the consumption and market betas of this investment strategy increase during recessions and times of crisis, when risk prices are high, implying that the unconditional betas understate its riskiness. We use the recent crisis as an example.

Suggested Citation

  • Hanno Lustig & Adrien Verdelhan, 2008. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk: A Reply," NBER Working Papers 13812, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:13812
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    Citations

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    Cited by:

    1. Matteo Maggiori, 2013. "The U.S. Dollar Safety Premium," 2013 Meeting Papers 75, Society for Economic Dynamics.
    2. S. Mouabbi, 2014. "An arbitrage-free Nelson-Siegel term structure model with stochastic volatility for the determination of currency risk premia," Working papers 527, Banque de France.
    3. Cosmin Ilut, 2012. "Ambiguity Aversion: Implications for the Uncovered Interest Rate Parity Puzzle," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(3), pages 33-65, July.
    4. Engel, Charles, 2014. "Exchange Rates and Interest Parity," Handbook of International Economics, Elsevier.
    5. Atanasov, Victoria & Nitschka, Thomas, 2014. "Currency excess returns and global downside market risk," Journal of International Money and Finance, Elsevier, vol. 47(C), pages 268-285.
    6. Lettau, Martin & Maggiori, Matteo & Weber, Michael, 2014. "Conditional risk premia in currency markets and other asset classes," Journal of Financial Economics, Elsevier, vol. 114(2), pages 197-225.
    7. Victoria Dobrynskaya, 2014. "Downside Market Risk of Carry Trades," Review of Finance, European Finance Association, vol. 18(5), pages 1885-1913.
    8. Emmanuel Farhi & Xavier Gabaix, "undated". "Rare Disasters and Exchange Rates," Working Paper 71001, Harvard University OpenScholar.
    9. Aidan Corcoran, 2009. "The Determinants of Carry Trade Risk Premia," The Institute for International Integration Studies Discussion Paper Series iiisdp287, IIIS.
    10. Anatolyev, Stanislav & Gospodinov, Nikolay & Jamali, Ibrahim & Liu, Xiaochun, 2015. "Foreign exchange predictability during the financial crisis: implications for carry trade profitability," FRB Atlanta Working Paper 2015-6, Federal Reserve Bank of Atlanta.
    11. Alexandra Janssen & Rahel Studer, 2014. "The Swiss franc's honeymoon," ECON - Working Papers 170, Department of Economics - University of Zurich, revised Jan 2017.
    12. Gourio, François & Siemer, Michael & Verdelhan, Adrien, 2013. "International risk cycles," Journal of International Economics, Elsevier, vol. 89(2), pages 471-484.
    13. Byrne, Joseph P & Ibrahim, Boulis Maher & Sakemoto, Ryuta, 2017. "Carry Trades and Commodity Risk Factors," MPRA Paper 80789, University Library of Munich, Germany.
    14. Victoria Dobrynskaya, 2015. "Currency Exposure to Downside Risk: Which Fundamentals Matter?," Review of International Economics, Wiley Blackwell, vol. 23(2), pages 345-360, May.
    15. Oleg Itskhoki & Dmitry Mukhin, 2017. "Exchange Rate Disconnect in General Equilibrium," NBER Working Papers 23401, National Bureau of Economic Research, Inc.
    16. Ivanova, Yuliya & Neely, Christopher J. & Weller, Paul A., 2014. "Can risk explain the profitability of technical trading in currency markets?," Working Papers 2014-33, Federal Reserve Bank of St. Louis, revised 14 Nov 2016.

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    • F31 - International Economics - - International Finance - - - Foreign Exchange

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