A Habit-Based Explanation of the Exchange Rate Risk Premium
This paper presents a model that reproduces the uncovered interest rate parity puzzle. Investors have preferences with external habits. Countercyclical risk premia and procyclical real interest rates arise endogenously. During bad times at home, when domestic consumption is close to the habit level,...
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| Other Authors: | |
| Format: | Article |
| Language: | en_US |
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American Finance Association/Wiley
2013
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| Online Access: | http://hdl.handle.net/1721.1/76223 https://orcid.org/0000-0002-0319-5531 |
| _version_ | 1811074805877702656 |
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| author | Verdelhan, Adrien Frederic |
| author2 | Sloan School of Management |
| author_facet | Sloan School of Management Verdelhan, Adrien Frederic |
| author_sort | Verdelhan, Adrien Frederic |
| collection | MIT |
| description | This paper presents a model that reproduces the uncovered interest rate parity puzzle. Investors have preferences with external habits. Countercyclical risk premia and procyclical real interest rates arise endogenously. During bad times at home, when domestic consumption is close to the habit level, the representative investor is very risk averse. When the domestic investor is more risk averse than her foreign counterpart, the exchange rate is closely tied to domestic consumption growth shocks. The domestic investor therefore expects a positive currency excess return. Because interest rates are low in bad times, expected currency excess returns increase with interest rate differentials. |
| first_indexed | 2024-09-23T09:55:47Z |
| format | Article |
| id | mit-1721.1/76223 |
| institution | Massachusetts Institute of Technology |
| language | en_US |
| last_indexed | 2024-09-23T09:55:47Z |
| publishDate | 2013 |
| publisher | American Finance Association/Wiley |
| record_format | dspace |
| spelling | mit-1721.1/762232022-09-30T17:46:45Z A Habit-Based Explanation of the Exchange Rate Risk Premium Verdelhan, Adrien Frederic Sloan School of Management Verdelhan, Adrien Frederic This paper presents a model that reproduces the uncovered interest rate parity puzzle. Investors have preferences with external habits. Countercyclical risk premia and procyclical real interest rates arise endogenously. During bad times at home, when domestic consumption is close to the habit level, the representative investor is very risk averse. When the domestic investor is more risk averse than her foreign counterpart, the exchange rate is closely tied to domestic consumption growth shocks. The domestic investor therefore expects a positive currency excess return. Because interest rates are low in bad times, expected currency excess returns increase with interest rate differentials. 2013-01-09T19:29:08Z 2013-01-09T19:29:08Z 2010-01 Article http://purl.org/eprint/type/JournalArticle 0022-1082 1540-6261 http://hdl.handle.net/1721.1/76223 Verdelhan, Adrien. “A Habit-Based Explanation of the Exchange Rate Risk Premium.” The Journal of Finance 65.1 (2010): 123–146. https://orcid.org/0000-0002-0319-5531 en_US http://dx.doi.org/10.1111/j.1540-6261.2009.01525.x Journal of Finance Creative Commons Attribution-Noncommercial-Share Alike 3.0 http://creativecommons.org/licenses/by-nc-sa/3.0/ application/pdf American Finance Association/Wiley SSRN |
| spellingShingle | Verdelhan, Adrien Frederic A Habit-Based Explanation of the Exchange Rate Risk Premium |
| title | A Habit-Based Explanation of the Exchange Rate Risk Premium |
| title_full | A Habit-Based Explanation of the Exchange Rate Risk Premium |
| title_fullStr | A Habit-Based Explanation of the Exchange Rate Risk Premium |
| title_full_unstemmed | A Habit-Based Explanation of the Exchange Rate Risk Premium |
| title_short | A Habit-Based Explanation of the Exchange Rate Risk Premium |
| title_sort | habit based explanation of the exchange rate risk premium |
| url | http://hdl.handle.net/1721.1/76223 https://orcid.org/0000-0002-0319-5531 |
| work_keys_str_mv | AT verdelhanadrienfrederic ahabitbasedexplanationoftheexchangerateriskpremium AT verdelhanadrienfrederic habitbasedexplanationoftheexchangerateriskpremium |