Salvaging the C-CAPM: Currency Carry Trade Risk Premia and Conditioning Information

We use a standard consumption-based asset pricing model incorporating conditioning information to explain the risk-return profile of currency carry trade portfolios. In contrast to previous work, we use a scaled stochastic discount factor instead of scaled or managed portfolio returns. Our conditioning variable is a forward-looking measure of the net foreign assets, arising from an intertemporal budget constraint, that allows for valuation changes in foreign assets and liabilities and has strong predictive power for multilateral exchange rates. We find that our conditional consumption CAPM that allow for time variation in consumption betas can price a large part of the variation in cross-section of carry trade portfolios. Taken together our results suggest that the consumption-based models do still have a role to play in explaining excess returns on carry trade strategies.