This is an asset pricing question. What is the difference between conditional and unconditional risk premia? Here's the context:

The fact that carry trade strategies typically earn positive average returns is a manifestation of the failure of the uncovered interest parity (UIP) hypothesis, a major longstanding puzzle in international finance. A longstanding consensus in the international finance literature attributed all of carry trade average returns to conditional risk premia, finding little evidence of nonzero unconditional risk premia on individual currencies throughoutmost ofthe 20th century (e.g., Lewis (1995)) Consequently, much of the literature has focused on explaining conditional currency risk premia by ruling out asymmetries (e.g., Verdelhan (2010), Bansal and Shaliastovich (2012), Colacito and Croce (2013)). However, Lustig, Roussanov, and Verdelhan (2011) show that unconditional currency risk premia are, in fact, substantial and Hassan and Mano (2014) further argue that they drive the bulk of carry trade profits.

Some explanation, and / or a reference would be greatly helpful.


In case someone finds this helpful, I'll answer my own question.

Risk premium, say for example on some risky assets such as stocks, is the expected return on the risky asset less the risk-free rate.

However, empirically we have that this risk premium on stocks is much larger than the riskfree rate and also that it varies quite a bit more. So we introduce the idea of conditional vs. unconditional, which speaks to this time-varying aspect.

Conditional risk premia means risk premia conditioning on time-$t$ information (so with a time-$t$ subscript as in conditional moments, conditional variance, etc.). So it is the conditional expectation of the return of a risky asset over the risk free rate, where the conditioning is done on the agent's available information at time-$t$. Although it depends on the model, this is an object that is in general time-varying.

Unconditional risk premia just means risk premia without conditioning on time-$t$ information. Generally, this is not time varying.

A good reference for learning about conditioning information on asset pricing models is Chapter 8 in John Cochrane's book "Asset Pricing".


Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.