We use a standard consumption-based asset pricing model incorporating conditioning information to explain the risk-return profile of currency carry trade portfolios. We use a scaled stochastic discount factor instead of scaled or managed portfolio returns as in previous work. Our conditioning variable is a forward-looking measure of net foreign assets. It arises from an intertemporal budget constraint and has predictive power for exchange rates. We find that our conditional consumption-CAPM is able to price a large part of the variation in cross-section of carry trade portfolios using cross-sectional as well as time series regression-based tests. Taken together, our results imply that the consumption-based models do still have a role to play in explaining excess returns on carry trade strategies.
- consumption CAPM
- Fama-MacBeth Regressions
- net foreign assets
- conditioning information
- conditional asset pricing models
Abhyankar, A., Gonzalez, A., & Klinkowska, O. (2011). Salvaging the C-CAPM: Currency Carry Trade Risk Premia and Conditioning Information. Social Science Electronic Publishing. https://doi.org/10.2139/ssrn.1927265