Equity tail risk and currency risk premiums
Zhenzhen Fan, Juan M. Londono, Xiao Xiao
Journal of Financial Economics · 2022 · Volume 143 · Issue 1
DOI: 10.1016/j.jfineco.2021.05.020
Abstract
We find that an option-based equity tail risk factor is priced in the cross section of currency returns; more exposed currencies offer a low risk premium because they hedge against equity tail risk. A portfolio that buys currencies with high equity tail beta and shorts those with low beta extracts the global component in the tail factor. The estimated price of risk of this novel global factor is consistently negative in currency carry and momentum portfolios, and in portfolios of other asset classes, suggesting that excess returns of these strategies can be partially understood as compensations for global tail risk.
Keywords
Option-implied equity tail risk, Carry trade, Global tail risk, Currency momentum, Currency returns
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