Template-Type: ReDIF-Paper 1.0

Author-Name: Adrien Verdelhan

Author-X-Name-First: Adrien			
Author-X-Name-Last: Verdelhan
Author-Email: av@bu.edu
Author-Workplace-Name: Department of Economics, Boston University

Author-Name: Hanno Lustig
Author-X-Name-First: Hanno 
Author-X-Name-Last:  Lustig
Author-Email: 
Author-Workplace-Name: UCLA/ NBER

Title: THE CROSS-SECTION OF FOREIGN
CURRENCY RISK PREMIA AND
CONSUMPTION GROWTH RISK




Abstract: Aggregate consumption growth risk explains why low interest rate currencies do
not appreciate as much as the interest rate diŽerential and why high interest rate
currencies do not depreciate as much as the interest rate diŽerential. We sort foreign
currency returns into portfolios based on foreign interest rates, and we test the Euler
equation of a domestic investor who invests in these currency portfolios. We ¯nd that
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 do not under the same conditions, low interest
rate currencies provide domestic investors with a hedge against domestic aggregate
consumption growth risk.




Length:51 pages
Creation-Date:2005-06 
Revision-Date: 
Publication-Status:
File-URL: http://www.bu.edu/econ/workingpapers/papers/Adrien%20Verdelhan/wp2005/FX_Xsection.pdf
File-Format: Application/pdf
File-Function: 
Number: WP2005-019
Classification-JEL: 
Keywords: Exchange Rates, Asset Pricing.
Handle: RePEc:bos:wpaper:WP2005-019