Volatility Risk Premia and Exchange Rate Predictability

Della Corte, Pasquale, Ramadorai, Tarun and Sarno, Lucio (2016) Volatility Risk Premia and Exchange Rate Predictability. Journal of Financial Economics, 120 (1). pp. 21-40.

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Abstract

We discover a new currency strategy with highly desirable return and diversification properties, which uses the predictive ability of currency volatility risk premia for currency returns. The volatility risk premium—the difference between expected realized volatility and model-free implied volatility—reflects the costs of insuring against currency volatility fluctuations. The strategy sells high insurance-cost currencies and buys low insurance-cost currencies. A distinctive feature of the strategy’s returns is that they are mainly generated by movements in spot exchange rates instead of interest rate differentials. We explore explanations for the profitability of the strategy, which cannot be understood using traditional risk factors.

Item Type: Article
Keywords: Exchange Rate, Hedgers, Order Flow, Predictability, Speculators, Volatility Risk Premium, finance
Subject(s): Finance
Date Deposited: 30 Nov 2018 10:49
Last Modified: 30 Nov 2018 10:49
URI: http://eureka.sbs.ox.ac.uk/id/eprint/7176

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