Global Variance Risk Premium and Forex Return Predictability

European Finance Association Doctoral Symposium 2012

54 Pages Posted: 22 Aug 2012 Last revised: 8 Jun 2017

Date Written: March 14, 2016

Abstract

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

Keywords: Global Variance Risk Premium; Excess Foreign Exchange (Forex) Return; Complete Markets; Predictability.

Suggested Citation

Aloosh, Arash, Global Variance Risk Premium and Forex Return Predictability (March 14, 2016). European Finance Association Doctoral Symposium 2012, Available at SSRN: https://ssrn.com/abstract=2133999 or http://dx.doi.org/10.2139/ssrn.2133999

Arash Aloosh (Contact Author)

Neoma Business School ( email )

1 Rue du Maréchal Juin,
Mont Saint Aignan, 76130
France
+33232824736 (Phone)

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