NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Countercyclical Currency Risk Premia

Hanno Lustig, Nikolai Roussanov, Adrien Verdelhan

NBER Working Paper No. 16427
Issued in September 2010
NBER Program(s):   AP   IFM

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 counter-cyclical 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 world-wide risk is the key driver of predictability.

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A data appendix is available at http://www.nber.org/data-appendix/w16427

This paper was revised on February 19, 2013

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Document Object Identifier (DOI): 10.3386/w16427

Published: Lustig, Hanno & Roussanov, Nikolai & Verdelhan, Adrien, 2014. "Countercyclical currency risk premia," Journal of Financial Economics, Elsevier, vol. 111(3), pages 527-553. citation courtesy of

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