Volatility Risk Premia in the G9 Currencies

Abstract

We study the volatility risk premia for the G9 currencies and find that they are negative, significant, both statistically and economically, and time varying. Our analysis indicates that the currency volatility risk premia covary with other prominent risk premia that have attracted attention in the asset pricing literature, namely the FX carry and the equity risk premium as well as the variance risk premia in other asset classes. However, once the equity variance risk premium is entered in a multiple regression, the statistical and economic significance of the former two is substantially impaired. We interpret these findings as evidence that volatility acts as an aggregate state variable that captures the evolution of the investor's opportunity set rather than just another statistical risk factor. Finally, we find no conclusive evidence that jump risk is priced within the volatility risk premia supporting the view that stochastic volatility and jumps have different effects and are separately priced.