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International correlation risk

Mueller, Philippe, Stathopoulos, Andreas and Vedolin, Andrea (2013) International correlation risk. FMG discussion papers, DP716. Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

We provide novel evidence of priced correlation risk in the foreign exchange market. Currencies that perform badly (well) during periods of high exchange rate correlation have high (low) average returns. We also show that high (low) interest rate currencies have high (low) correlation risk exposure, providing a risk-based justification for the carry trade. To address our empirical findings, we consider a general equilibrium model that incorporates preferences characterized by external habit formation and home bias. In our model, currencies which depreciate when conditional exchange rate correlation is high command high risk premia due to their adverse exposure to global risk aversion shocks.

Item Type: Monograph (Discussion Paper)
Official URL: http://www2.lse.ac.uk/fmg/home.aspx
Additional Information: © 2013 The Authors
Library of Congress subject classification: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Journal of Economic Literature Classification System: F - International Economics > F3 - International Finance > F31 - Foreign Exchange
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing; Futures Pricing
Sets: Departments > Finance
Collections > Economists Online
Research centres and groups > Financial Markets Group (FMG)
Collections > LSE Financial Markets Group (FMG) Working Papers
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: DP716
Funders: The Suntory and Toyota International Centres for Economics and Related Disciplines
Date Deposited: 16 Apr 2012 10:15
URL: http://eprints.lse.ac.uk/43087/

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