Term-Structure of Equity Risk and the Cross-Section of Currency Returns

• Grant number: 24/16089-5
• Support Opportunities: Scholarships abroad - Research Internship - Doctorate (Direct)
• Start date: January 20, 2025
• End date: January 19, 2026
• Field of knowledge: Applied Social Sciences - Economics - International Economy
• Principal Investigator: Marco Antonio Cesar Bonomo
• Grantee: Mohammed Mehdi Kaebi
• Supervisor: Christopher Polk
• Host Institution: Instituto de Ensino e Pesquisa (Insper). São Paulo , SP, Brazil
• Institution abroad: University of London, England
• Associated to the scholarship: 24/01046-9 - Currency carry under falling stars, BP.DD

Abstract

This research project proposes novel equity-based currency risk factors. We use the term-structure of equity risk to build currency risk factors and show that they are priced in the cross-section of currency returns. Currencies more exposed to the level and curvature risk-factors offer a lower risk premium, while those more exposed to the slope factor offer a higher risk-premium. A portfolio that buys the high risk factor exposure currencies and shorts the low risk factor exposure currencies captures risk-return dispersion, and the excess returns of these strategies can be understood as compensation for a globally traded shock.