The Term Structure of Currency Carry Trade Risk Premia

The Term Structure of Currency Carry Trade Risk Premia

By
Hanno Lustig, Adrien Verdelhan, Andreas Stathopoulos
American Economic Review (accepted). June
2019

Fixing the investment horizon, the returns to currency carry trades decrease as the maturity of the foreign bonds increases. The local currency term premia, which increase with the maturity, offset the currency risk premia. The time-series predictability of foreign bond returns in dollars similarly declines with the bonds’ maturities. Leading no-arbitrage models in international finance cannot match the downward term structure of currency carry trade risk premia. We derive a simple preference-free condition that no-arbitrage models need to satisfy to match the carry trade risk premia on long term bonds.n