Conditional Risk Premia in Currency Markets and Other Asset Classes

Martin Lettau, Matteo Maggiori, Michael Weber

NBER Working Paper No. 18844
Issued in February 2013
NBER Program(s):   AP   IFM

The downside risk CAPM (DR-CAPM) can price the cross section of currency returns. The market-beta differential between high and low interest rate currencies is higher conditional on bad market returns, when the market price of risk is also high, than it is conditional on good market returns. Correctly accounting for this variation is crucial for the empirical performance of the model. The DR-CAPM can jointly explain the cross section of equity, commodity, sovereign bond and currency returns, thus offering a unified risk view of these asset classes. In contrast, popular models that have been developed for a specific asset class fail to jointly price other asset classes.

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An online appendix is available for this publication.

Acknowledgments

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