Date of this Version
Journal of Financial Economics
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.
© 2014. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/.
Lustig, H., Roussanov, N., & Verdelhan, A. (2014). Countercyclical Currency Risk Premia. Journal of Financial Economics, 111 (3), 527-553. http://dx.doi.org/10.1016/j.jfineco.2013.12.005
Date Posted: 27 November 2017
This document has been peer reviewed.