The Term Structure of Currency Futures' Risk Premia

The use of futures exchange contracts instead of forwards completes the maturityspectrum of the correlation between the spot yield and the premium. We find that theforward premium puzzle (FPP) depends significantly on the maturity horizon of thefutures contract and the choice of the sampling period. The FPP appears to be a pre-crisis phenomenon and is only observed for maturities longer than about one month.We find that differences in the exposure to risk help to explain the cross-sectional spreadin currency excess returns in a significant way. Currencies with a low futures premiumare less exposed to market, consumption and carry trade risk than currencies with ahigh futures premium. However, this only applies for medium and longer asset matu-rities. Considering that most studies that test the validity of a risk-based approach tocurrency excess returns focus on short maturity securities, our results explains why thisapproach is so often rejected