Currency Factors

Arash Aloosh and Geert Bekaert

No 25449, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We examine the ability of existing and new factor models to explain the comovements of G10- currency changes, measured using the novel concept of “currency baskets”, representing the overall movement of a particular currency. Using a clustering technique, we find a clear two-block structure in currency comovements with the first block containing mostly the dollar currencies, and the other the European currencies. A factor model incorporating this “clustering” factor and two additional factors, a commodity currency factor and a “world” factor based on trading volumes, fits currency basket correlations much better than extant factors, such as value and carry, do. In particular, it explains on average about 60% of currency variation and generates a root mean squared error relative to sample correlations of only 0.11. The model also fits comovements in emerging market currencies well. Economically, the correlations between currency baskets underlying the factor structure are inversely related to the physical distances between countries. The factor structure is also related to the exposure of the corresponding pricing kernels with respect to the global pricing kernel and is apparent in cross-country retail sales growth data.

JEL-codes: C23 C53 G11 (search for similar items in EconPapers)
Date: 2019-01
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

Published as Arash Aloosh & Geert Bekaert, 2022. "Currency Factors," Management Science, vol 68(6), pages 4042-4064.

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Journal Article: Currency Factors (2022)
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