Global Variance Risk Premium and Forex Return Predictability

Aloosh, Arash (2014): Global Variance Risk Premium and Forex Return Predictability.

Abstract

In a long-run risk model with stochastic volatility and frictionless markets, I express expected forex returns as a function of consumption growth variances and stock variance risk premiums (VRPs)—the difference between the risk-neutral and statistical expectations of market return variation. This provides a motivation for using the forward-looking information available in stock market volatility indices to predict forex returns. Empirically, I find that stock VRPs predict forex returns at a one-month horizon, both in-sample and out-of-sample. Moreover, compared to two major currency carry predictors, global VRP has more predictive power for currency carry trade returns, bilateral forex returns, and excess equity return differentials.

• Item Type: MPRA Paper
• Language: English
• Keywords: Global Variance Risk Premium; Excess Foreign Exchange (Forex) Return; Frictionless Markets; Predictability.
• Subjects: F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F3 - International Finance > F37 - International Finance Forecasting and Simulation: Models and Applications; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

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