1. with two risk factors: the average excess returns of a U.S. investor on currency markets (denoted RX, as in the two papers above) and the risk-reversals at 25 delta on S&P 500 Index options (denoted RR). The U.S. S&P 500 Index options are used to measure global disaster equity risk because of the lack of data on out-of-the-money equity options in other countries in the sample. Risk-reversals are significantly priced in the cross-section of carry trade excess returns. Both factors help to explain more than 90% of the cross-section of average excess returns. Loadings on the dollar risk factor are close to 1 and do not account for the cross-section of portfolio returns. Loadings on risk-reversals, however, differ markedly across portfolios: they range from 0.87 to ?0.96. Unsurprisingly, the same pattern characterizes our smaller set of countries and portfolios (for which betas vary from 0.81 to ?0.76). High interest rate currencies tend to depreciate during bad economic periods, when risk-reversals are high, while low interest rate currencies tend to appreciate during those times;Lustig;the Online Appendix reports asset pricing tests on the six portfolios of,2011
2. Do Option Markets Correctly Price the Probabilities of Movement of the Underlying Asset?;Wang Ait-Sahalia;A large literature focuses instead on equity and bond markets: see Duffie, Pan, and,2000
3. Arbitrage in the Foreign Exchange Market: Turning on the Microscope;Q Akram;Journal of International Economics,2008