Pricing Implications of Covariances and Spreads in Currency Markets

Optimal and naive diversification in currency markets

Thomas Maurer, Thuy-Duong Tô and Ngoc-Khanh Tran

The Review of Asset Pricing Studies, 2022, vol. 12, issue 1, 336-388

Abstract: We introduce a covariance and spread (i.e., exchange rate forward discount) adjusted carry factor that prices the cross-section of FX market returns, where many other single- and multifactor models fail. Both the covariance matrix of exchange rate growths and forward discounts contain important information for pricing that is not captured by well-known factors. The time-varying conditional covariance matrix and forward discounts forecast future realized currency returns. (JEL F31, F37, G12, G15, G17)

Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:oup:rasset:v:12:y:2022:i:1:p:336-388.

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