The Global Factor Structure of Exchange Rates

Andrea Vedolin, Sofonias Alemu Korsaye and Fabio Trojani

No 15337, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We provide a model-free framework to study the global factor structure of exchange rates. To this end, we propose a new methodology to estimate international stochastic discount factors (SDFs) that jointly price cross-sections of international assets, such as stocks, bonds, and currencies, in the presence of frictions. We theoretically establish a two-factor representation for the cross-section of international SDFs, consisting of one global and one local factor, which is independent of the currency denomination. We show that our two-factor specification prices a large cross-section of international asset returns, not just in- but also out-of-sample with R2s of up to 80%.

Keywords: International asset pricing; Stochastic discount factor; Factor models; Financial frictions; Market segmentation; Incomplete markets; Capital flows; Regularization; Lasso (search for similar items in EconPapers)
JEL-codes: F31 G15 (search for similar items in EconPapers)
Date: 2020-10
New Economics Papers: this item is included in nep-cwa, nep-ifn, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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