Option-Implied Currency Risk Premia - Princeton University

Figure 5. Option-Implied Currency Risk Premia: Conditional carry trade portfolio. This figure illustrates the model-implied
currency risk premium decomposition for the conditional G10 currency carry trade portfolio, which is spread-weighted and dollarneutral.
The top panel plots the time series of the total, model-implied risk premium, and the contribution from exposure to the
global currency risk factor (HML F X ). Since the empirical factor mimicking portfolio is constructed to be dollar-neutral, the
entirety of the model risk premium reflects compensation for exposure to the global factor. The middle panel decomposes the
model-implied portfolio risk premium into compensation for Gaussian and non-Gaussian innovations. The panel plots the share of
the risk premium due to each component; the mean share due to each component is reported in the title of the respective subplots.
The bottom panel decomposes the portfolio risk premium into contributions from the variance, skewness, and higher moments
(other) of the global pricing kernel shock, L g Z t
. The plots report data spanning the period 1999:1-2012:6, and are based on the
output of Specification I.
HML FX
Risk Premium Decomposition − By risk factor: 3.46% (Total), 3.46% (Global)
0.6
0.5
Total
Global
0.4
0.3
0.2
0.1
0
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1
HML FX
Risk Premium Decomposition − By shock type: 57.99% (Non−Gaussian)
0.8
0.6
0.4
0.2
Non−Gaussian [%]
Gaussian [%]
0
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1
HML FX
Risk Premium Decomposition − By moment: 85.22% (2nd), 9.48% (3rd)
0.8
0.6
0.4
0.2
Variance [%]
Skewness [%]
Other [%]
0
Dec98 May00 Sep01 Jan03 May04 Sep05 Feb07 Jun08 Oct09 Feb11 Jun12