Switching Risk Off: FX Correlations and Risk Premia

Alessandro Beber () and Michael Brandt

No 10214, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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: Fx correlation; Risk-off; Currency risk premia (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2014-10
New Economics Papers: this item is included in nep-rmg
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Citations: View citations in EconPapers (6)

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