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Board of Governors of the Federal Reserve System (U.S.)
International Finance Discussion Papers
Uncertainty, Curreny Exess Returns, and Risk Reversals
Lucas F. Husted
John H. Rogers
Bo Sun
Abstract

In this paper we provide strong evidence that heightened uncertainty in the U.S. real economy or financial markets significantly raises excess returns to the currency carry trade. We posit that this works through the influence of uncertainty on global investors' risk preferences. Macro and financial uncertainty also lower foreign exchange risk reversals, an effect that is particularly strong for high interest rate portfolios. Our results are consistent with the idea that an increase in uncertainty regarding the U.S. economy or financial markets increases investors' risk aversion, which in turn drives up the expected returns and the cost of protection against crash risk in the FX market.


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Lucas F. Husted & John H. Rogers & Bo Sun, Uncertainty, Curreny Exess Returns, and Risk Reversals, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 1196, Feb 2017.
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Keywords: Exchange rates ; Uncovered interest parity ; Uncertainty
DOI: 10.17016/IFDP.2017.1196
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