Abstract
We investigate the pricing of volatility risks in currency markets. First, we show that pricing ability of volatility risk is concentrated in some of its components. Diffusive volatility dominates jump volatility in pricing carry trade returns, while jump volatility is important in jointly explaining carry trade and momentum returns. Both short-run and long-run volatility components are priced, and the short-run component is more important in general. Second, we suggest that factors similar to volatility in identifying bad states, i.e. volatility of volatility and cross sectional volatility are also priced and are not fully subsumed by conventional volatility measures.
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