Factor investing and currency portfolio management

Danyang Li, Zhekai Zhang and Mario Cerrato

International Review of Financial Analysis, 2023, vol. 87, issue C

Abstract: Currency-specific pricing factors are pervasive in international asset pricing. However, portfolio and risk management based on forex factors, instead of individual currencies, are rarely discussed. This paper tries to fill this gap by modelling dynamic correlations and non-normality among forex factors. By considering the four most popular forex factors: the dollar risk factor, the carry trade factor, the currency momentum factor, and the currency value factor, we find that a dynamic conditional correlation copula (DCC-copula) model with skewed-t kernel fits the joint distribution well. We show that, for risk-averse investors who focus on factor investing or employ the forex factors to resize the specific risk exposure, ignoring the tail dependence structure of forex factors brings significant costs.

Keywords: Forex factor; Portfolio management; Risk management; Copula; Joint distribution (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:87:y:2023:i:c:s1057521923001424

DOI: 10.1016/j.irfa.2023.102626

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