UNIVERSITY OF CALIFORNIA, BERKELEY'S HAAS SCHOOL OF BUSINESS -Finance Professor Martin Lettau has received the 2013 AQR Insight Award for his research about how an extension of the widely taught capital asset pricing model can explain returns of equity, commodity, sovereign bonds, and currencies and offer a unified risk view of these investments.
The winning paper, "Conditional Currency Risk Premia," is co-authored with Berkeley-Haas alumnus Matteo Maggiori, Ph.D. 12, and Michael Weber, a current Berkeley-Haas Ph.D. student. They will share the first prize of $60,000.
The paper weighs into the ongoing debate on whether currency returns can be explained by their exposure to risk factors. The authors find that currency returns can be explained by a risk model where investors are particularly concerned about downside risk, called "the downside risk capital asset pricing model."
According to Lettau, it is well-known that high-yield currencies earn higher returns than low yield currencies. The authors show that returns of high-yield currencies are highly correlated with aggregate market returns when market returns are particularly low. Low-yield currencies have the opposite correlation pattern. If investors are particularly concerned about times when market returns are very low, the difference in downside risk of high-yield currencies relative to low-yield currencies can explain their differences in returns. This relationship is characteristic not only of currencies but also of equities, commodities, and sovereign bonds, thus providing a unified risk view of these markets.
Lettau is a member of the Haas Finance Group and the Kruttschnitt Family Chair in Financial Institutions.
The winning paper was presented to AQR investment teams in Greenwich, CT last month.
Applied Quantitative Research (AQR) provides global investment services, including investment philosophies based on empirical finance research. AQR established the Insight Award to honor finance research that offers significant practical implications for improving investment performance.
"This paper is an example of relevant empirical research motivated by economic intuition and financial theory. It explores the implication of securities' downside risk (the risk of losses during period of market distress), a topic of extreme relevance for both asset managers and investors," says AQR Co-Founding Principal David G. Kabiller. "This is the precisely kind of empirical research the AQR Insight Award was created to encourage: rigorous, relevant empirical analysis motivated by economic theory."