Systematic consumption risk in currency returns. (June 2017)

• Record Type: Journal Article
• Authors: Hoffmann, Mathias; Studer-Suter, Rahel
• Is Part Of: Journal of international money and finance. Volume 74(2017)
• Page Start: 187
• Page End: 208
• Publication Date: 2017-06
• Subjects: E44 -- F31 -- F44 -- G12 -- G15; Foreign exchange -- Uncovered interest parity -- Carry trade returns -- Consumption risk -- Asset pricing -- Habit model; International finance -- Periodicals; Foreign exchange -- Periodicals; Finances internationales -- Périodiques; Change -- Périodiques; Foreign exchange; International finance; Periodicals; 332.04205
• DOI: 10.1016/j.jimonfin.2017.01.001
• Languages: English
• ISSNs: 0261-5606

Abstract

Abstract: We sort currencies into portfolios by countries' past consumption growth. The excess return of the highest- over the lowest-consumption-growth portfolio – our consumption carry factor – compensates for negative returns during world-wide downturns and prices the cross-section of portfolio-sorted and of bilateral currency returns. Empirically, sorting currencies on consumption growth is very similar to sorting currencies on interest rates. We interpret these stylized facts in a habit formation model: sorting currencies on past consumption growth approximates sorting on risk aversion. Low (high) risk-aversion currencies have high (low) interest rates and depreciate (appreciate) in times of global turmoil.