Expected Currency Returns and the Term Structure of Risk Preferences
Dr. Pasquale Della Corte
Associate Professor of Finance
Imperial College Business School
Imperial College London
This paper challenges the prevailing notion that investors’ preferences remain independent of their investment horizon by uncovering a term structure of risk preferences. Theoretically, we extract a utility-free measure of risk preferences without temporal or horizon restrictions. Empirically, we estimate this measure using professional forecasts and expected risk premia derived from FX option prices. Our analysis of G30 currencies from 1996 to 2020 reveals that the fear of high-order risk is more pronounced in the shorter term, indicating a downward-sloping term structure of investor risk preferences. Moreover, we find that this negative slope becomes more pronounced during adverse times but shifts to an upward slope during favorable periods. These insights offer valuable guidance for enriching existing asset pricing models with horizon-dependent risk preferences, shedding new light on the dynamics of risk premia across different time horizons.
