A Habit-Based Explanation of the Exchange Rate Risk Premium
This paper presents a model that reproduces the uncovered interest rate parity puzzle, based on a time-varying business-cycle related risk premium. Agents have preferences with external habits. During bad times in the home market, when the domestic habit is close to domestic consumption level, the exchange rate becomes more sensitive to domestic than to foreign aggregate consumption growth shocks. As a result, the foreign currency depreciates in case of a negative consumption growth shock at home. Hence, investing in foreign currency is risky in bad times, when domestic interest rates are low relative to foreign interest rates.
Year of publication: |
2006-06
|
---|---|
Authors: | Verdelhan, Adrien |
Institutions: | Department of Economics, Boston University |
Saved in:
Saved in favorites
Similar items by person
-
The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk
Lustig, Hanno, (2006)
-
A Habit-Based Explanation of the Exchange Rate Risk Premium
Verdelhan, Adrien, (2005)
-
The Wealth-Consumption Ratio: A Litmus Test for Consumption-based Asset Pricing ModelsĀ¤
Lustig, Hanno, (2007)
- More ...