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American Economic Review Vol. 97 No. 1 2007

The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk

Hanno Lustig1; Adrien Verdelhan2

1 Department of Economics, UCLA, Box 951477, Los Angeles, CA 90095, and National Bureau of Economic Research. · 2 Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215, and Centre de recherches de la Banque de France, 29 rue Croix des petits champs, Paris 75049 France.

Abstract

Aggregate consumption growth risk explains why low interest rate currencies do not appreciate as much as the interest rate differential and why high interest rate currencies do not depreciate as much as the interest rate differential. Domestic investors earn negative excess returns on low interest rate currency portfolios and positive excess returns on high interest rate currency portfolios. Because high interest rate currencies depreciate on average when domestic consumption growth is low and low interest rate currencies appreciate under the same conditions, low interest rate currencies provide domestic investors with a hedge against domestic aggregate consumption growth risk.

DOI
10.1257/aer.97.1.89
Volume
97
Issue
1
Pages
89-117
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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