Working Paper: NBER ID: w19623
Authors: Hanno Lustig; Andreas Stathopoulos; Adrien Verdelhan
Abstract: Fixing the investment horizon, the returns to currency carry trades decrease as the maturity of the foreign bonds increases. The local currency term premia, which increase with the maturity, offset the currency risk premia. The time-series predictability of foreign bond returns in dollars similarly declines with the bonds' maturities. Leading no-arbitrage models in international finance cannot match the downward term structure of currency carry trade risk premia. We derive a simple preference-free condition that no-arbitrage models need to satisfy to match the carry trade risk premia on long term bonds.
Keywords: Currency carry trade; Risk premia; No-arbitrage models
JEL Codes: F20; F31; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Maturity of foreign bonds (G15) | Average excess return from currency carry trades (F31) |
| Local currency term premia (F31) | Currency risk premia (F31) |
| Maturity of foreign bonds (G15) | Predictability of cross-country differences in dollar bond returns (G15) |