Working Paper: NBER ID: w18844
Authors: Martin Lettau; Matteo Maggiori; Michael Weber
Abstract: 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 rationalize the cross section of equity, equity index options, 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.
Keywords: downside risk; currency returns; asset pricing; CAPM
JEL Codes: F31; F34; G11; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| downside risk (D81) | expected returns (G17) |
| high yield currencies (F31) | higher excess returns (G19) |
| market returns during downturns (G17) | higher excess returns (G19) |
| downside risk exposure (D81) | expected returns (G17) |
| drCAPM (G19) | cross-section of currency returns (G15) |
| market beta differential (C46) | higher excess returns (G19) |
| drCAPM (G19) | variation in returns (G11) |