The U.S. Dollar and variance risk premia imbalances

Mads Markvart Kjær; Anders Merrild Posselt

doi:10.1111/fire.12407

The U.S. Dollar and variance risk premia imbalances

Mads Markvart Kjær, Anders Merrild Posselt^*

^*Corresponding author for this work

Department of Economics and Business Economics

Research output: Contribution to journal/Conference contribution in journal/Contribution to newspaper › Journal article › Research › peer-review

Abstract

We present a novel predictor for the Dollar factor: variance risk premia imbalances (VPI), defined as the difference in variance risk premium between the U.S. and non-U.S. countries. We argue that VPI theoretically proxies the average volatility differential between the U.S. and non-U.S. stochastic discount factors. VPI significantly predicts monthly U.S. dollar movements, explains roughly 10% of next-month Dollar factor variation, and generates significant economic value for investors. We rationalize our findings in a simple consumption-based asset pricing model.

Original language	English
Journal	Financial Review
Volume	60
Issue	1
Pages (from-to)	173-200
Number of pages	28
ISSN	0732-8516
DOIs	https://doi.org/10.1111/fire.12407
Publication status	Published - Feb 2025

Keywords

currency return predictability
the U.S. Dollar
variance risk premium

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10.1111/fire.12407Licence: CC BY-NC-ND

Cite this

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abstract = "We present a novel predictor for the Dollar factor: variance risk premia imbalances (VPI), defined as the difference in variance risk premium between the U.S. and non-U.S. countries. We argue that VPI theoretically proxies the average volatility differential between the U.S. and non-U.S. stochastic discount factors. VPI significantly predicts monthly U.S. dollar movements, explains roughly 10% of next-month Dollar factor variation, and generates significant economic value for investors. We rationalize our findings in a simple consumption-based asset pricing model.",

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AB - We present a novel predictor for the Dollar factor: variance risk premia imbalances (VPI), defined as the difference in variance risk premium between the U.S. and non-U.S. countries. We argue that VPI theoretically proxies the average volatility differential between the U.S. and non-U.S. stochastic discount factors. VPI significantly predicts monthly U.S. dollar movements, explains roughly 10% of next-month Dollar factor variation, and generates significant economic value for investors. We rationalize our findings in a simple consumption-based asset pricing model.

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The U.S. Dollar and variance risk premia imbalances

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Keywords

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