Essays on the Currency Risk Premium

In this dissertation, I study the empirical behavior of currency risk premium. I document predictability of currency excess returns in the data, and rationalize the observed predictability in asset pricing models featuring no arbitrage.In Chapter 1, I study joint time variation in expected bond and currency excess returns across G10 countries. Exploiting the documented fact that the Cochrane-Piazzesi factor explains most of the variation in expected bond excess returns, I investigate whether it predict currency excess return as well. I find countrywise differenced Cochrane-Piazzesi factors predicts currency excess returns, both in time-series and cross-sectional. Specifically, countries with higher CP factors tend to have lower subsequent currency excess returns. The predictability survives after various robustness checks. An international affine term structure model rationalizes the predictability.In Chapter 2, I study the role of monetary policy rules in explaining the observed returns from currency carry trades. Following standard practice, I estimate Taylor-type interest rate rules for G10 countries. I find that countries exhibit a heterogeneous degree of inflation response in terms of nominal rate adjustment. This heterogeneity strongly correlates with the returns, risk-adjusted returns, and portfolio positions of the currency carry trade in the data. I find that an equilibrium asset pricing model in which countries commit to interest rate feedback rules with heterogeneous inflation responses can qualitatively replicate these empirical correlations. A calibrated version of the model matches the magnitude of observed moments of the currency excess return.