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The Term Structure of Currency Carry Trade Risk Premia

Author

Listed:
  • Andreas Stathopoulos

    (University of Southern California)

  • Adrien Verdelhan

    (MIT Sloan)

  • Hanno Lustig

    (Anderson School of Business)

Abstract

We find that average returns to currency carry trades decrease signicantly as the maturity of the foreign bonds increases, because investment currencies tend to have small local bond term premia. The downward term structure of carry trade risk premia is informative about the temporal nature of risks that investors face in currency markets. We show that long-maturity currency risk premia only depend on the domestic and foreign permanent components of the pricing kernels, since transitory currency risk is automatically hedged by interest rate risk for long-maturity bonds. Our findings imply that there is more cross-border sharing of permanent than transitory shocks.

Suggested Citation

  • Andreas Stathopoulos & Adrien Verdelhan & Hanno Lustig, 2014. "The Term Structure of Currency Carry Trade Risk Premia," 2014 Meeting Papers 837, Society for Economic Dynamics.
  • Handle: RePEc:red:sed014:837
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    References listed on IDEAS

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    Cited by:

    1. Backus, David & Boyarchenko, Nina & Chernov, Mikhail, 2018. "Term structures of asset prices and returns," Journal of Financial Economics, Elsevier, vol. 129(1), pages 1-23.
    2. Emmanuel Farhi & Xavier Gabaix, "undated". "Rare Disasters and Exchange Rates," Working Paper 71001, Harvard University OpenScholar.

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