The Term Structure of Currency Futures' Risk Premia

Bernoth, Kerstin, de Vries, G. Casper and von Hagen, Jürgen (2021): "The term structure of currency futures’ risk premia", Journal of Money, Credit and Banking, 2021, available online DOI: 10.1111/jmcb.12872

40 Pages Posted: 14 Dec 2021

See all articles by Kerstin Bernoth

Kerstin Bernoth

German Institute for Economic Research (DIW Berlin)

Jürgen von Hagen

University of Bonn

Casper de Vries

Erasmus University Rotterdam (EUR); Tinbergen Institute

Date Written: November 4, 2021

Abstract

The use of futures exchange contracts instead of forwards completes the maturity
spectrum of the correlation between the spot yield and the premium. We find that the
forward premium puzzle (FPP) depends significantly on the maturity horizon of the
futures contract and the choice of the sampling period. The FPP appears to be a pre-
crisis phenomenon and is only observed for maturities longer than about one month.
We find that differences in the exposure to risk help to explain the cross-sectional spread
in currency excess returns in a significant way. Currencies with a low futures premium
are less exposed to market, consumption and carry trade risk than currencies with a
high futures premium. However, this only applies for medium and longer asset matu-
rities. Considering that most studies that test the validity of a risk-based approach to
currency excess returns focus on short maturity securities, our results explains why this
approach is so often rejected.

Keywords: forward premium puzzle, uncovered interest parity, futures rates, price of risk, currency excess returns, capital asset pricing model

JEL Classification: F31, F37, G12, G13, G15

Suggested Citation

Bernoth, Kerstin and Hagen, Jürgen von and de Vries, Casper, The Term Structure of Currency Futures' Risk Premia (November 4, 2021). Bernoth, Kerstin, de Vries, G. Casper and von Hagen, Jürgen (2021): "The term structure of currency futures’ risk premia", Journal of Money, Credit and Banking, 2021, available online DOI: 10.1111/jmcb.12872, Available at SSRN: https://ssrn.com/abstract=3979532

Kerstin Bernoth (Contact Author)

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Jürgen von Hagen

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

Casper De Vries

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

Tinbergen Institute

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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