Switching Risk Off: FX Correlations and Risk Premia

72 Pages Posted: 21 Oct 2014

See all articles by Alessandro Beber

Alessandro Beber

Cass Business School; Centre for Economic Policy Research (CEPR)

Michael W. Brandt

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Jason Cen

University of Exeter Business School

Multiple version iconThere are 2 versions of this paper

Date Written: October 2014

Abstract

Risk-off refers to a change in risk preferences and the associated portfolio rebalancing. We identify these episodes using the switch to a polarized correlation regime of foreign-exchange returns. These risk-off transitions are relatively infrequent but noticeably increasing over time, are persistent and associated with geopolitical events, and seem unrelated to changes in macroeconomic fundamentals and to volatility or average correlation shocks. Risk-off switches have very significant effects on the returns of a large number of asset classes and trading strategies, with risky and safe asset returns being penalized and favored, respectively. This evidence is consistent with a price pressure story induced by portfolio rebalancing, as we document that risk-off transitions are associated with significant changes in the positions of professional investors across different futures markets.

Keywords: currency risk premia, FX correlation, risk-off

JEL Classification: G12

Suggested Citation

Beber, Alessandro and Brandt, Michael W. and Cen, Jason, Switching Risk Off: FX Correlations and Risk Premia (October 2014). CEPR Discussion Paper No. DP10214, Available at SSRN: https://ssrn.com/abstract=2512742

Alessandro Beber (Contact Author)

Cass Business School ( email )

London, EC2Y 8HB
Great Britain

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Michael W. Brandt

Duke University - Fuqua School of Business ( email )

1 Towerview Drive
Durham, NC 27708-0120
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jason Cen

University of Exeter Business School ( email )

Streatham Court
Xfi Building, Rennes Dr.
Exeter, EX4 4JH
United Kingdom

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