【Topic】Volatility Risk Premia and Exchange Rate Predictability
【Speaker】Pasquale DELLA CORTE，Assistant Professor,Imperial College London
【Time】13:45—15:15, 2013-10-17，Thursday
【Venue】Room 501, Weilun Building, Tsinghua SEM.
【Organizer】Department of Finance
【Target Audience】Faculty Members and Graduate Students
Pasquale DELLA CORTE is an Assistant Professor of Finance at Imperial College Business School, Imperial College London, and an Associate Editor of the Journal of Money, Credit and Banking (JMCB). Pasquale’s research interests focus on international finance, market microstructure, empirical asset pricing, portfolio choice and Bayesian econometrics. Pasquale's research has been published in theJournal of Financial Economics, theReview of Economics and Statistics, theReview of Financial Studies, and theJournal of Empirical Finance, and featured in theFT,VoxEuandEconoMonitor.Pasquale has also held visiting positions at the Federal Reserve Bank of St. Louis, the Washington University in St. Louis, and Norges Bank.
We investigate the predictive information content in foreign exchange volatility risk premia for exchange rate returns. The volatility risk premium is the difference between realized volatility and a model-free measure of expected volatility that is derived from currency options, and reflects the cost of insurance against volatility .fluctuations in the underlying currency. We find that a portfolio that sells currencies with high insurance costs and buys currencies with low insurance costs generates sizeable out-of-sample re- turns and Sharpe ratios. These returns are almost entirely obtained via predictability of spot exchange rates rather than interest rate differentials, and these predictable spot returns are far stronger than those from carry trade and momentum strategies. Canonical risk factors cannot price the returns from this strategy, which can be understood, however, in terms of a simple mechanism with time-varying limits to arbitrage.
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