Countercyclical currency risk premia |
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Authors: | Hanno Lustig Nikolai Roussanov Adrien Verdelhan |
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Institution: | 1. Anderson School of Management, University of California at Los Angeles, Box 951477, Los Angeles, CA 90095, United States;2. The Wharton School, University of Pennsylvania, 3620 Locust Walk, Philadelphia, PA 19104, United States;3. MIT Sloan, 100 Main Street, Cambridge, MA 02139, United States;4. National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02139, United States |
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Abstract: | We describe a novel currency investment strategy, the ‘dollar carry trade,’ which delivers large excess returns, uncorrelated with the returns on well-known carry trade strategies. Using a no-arbitrage model of exchange rates we show that these excess returns compensate U.S. investors for taking on aggregate risk by shorting the dollar in bad times, when the U.S. price of risk is high. The countercyclical variation in risk premia leads to strong return predictability: the average forward discount and U.S. industrial production growth rates forecast up to 25% of the dollar return variation at the one-year horizon. The estimated model implies that the variation in the exposure of U.S. investors to worldwide risk is the key driver of predictability. |
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Keywords: | G12 G15 F31 |
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