Working Paper: NBER ID: w13812
Authors: Hanno Lustig; Adrien Verdelhan
Abstract: The U.S. consumption growth beta of an investment strategy that goes long in high interest rate currencies and short in low interest rate currencies is large and significant. The price of consumption risk is significantly different from zero, even after accounting for the sampling uncertainty introduced by the estimation of the consumption betas. The constant in the regression of average returns on consumption betas is not significant. In addition, the consumption and market betas of this investment strategy increase during recessions and times of crisis, when risk prices are high, implying that the unconditional betas understate its riskiness. We use the recent crisis as an example.
Keywords: currency risk premia; consumption growth risk; carry trade; risk-based explanation
JEL Codes: F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| economic condition (low consumption growth) (E21) | depreciation of high interest rate currencies (F31) |
| high interest rate currencies (F31) | exposure to aggregate consumption growth risk (E21) |
| low interest rate currencies (F31) | lower exposure to aggregate consumption growth risk (E21) |
| consumption betas (high interest rate currencies) (F31) | larger than consumption betas (low interest rate currencies) (F31) |
| price of consumption risk (D11) | significantly different from zero (C12) |
| consumption and market betas (E21) | increase during crises (H12) |
| average excess returns on currency investments (F31) | explained by exposure to consumption growth risk (D11) |