International correlation risk

Philippe Mueller (), Andreas Stathopoulos and Andrea Vedolin

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We show that the cross-sectional dispersion of conditional foreign exchange (FX) correlation is countercyclical and that currencies that perform badly (well) during periods of high dispersion yield high (low) average excess returns. We also find a negative cross-sectional association between average FX correlations and average option-implied FX correlation risk premiums. Our findings show that while investors in spot currency markets require a positive risk premium for exposure to high dispersion states, FX option prices are consistent with investors being compensated for the risk of low dispersion states. To address our empirical findings, we propose a no-arbitrage model that features unspanned FX correlation risk.

Keywords: correlation risk; exchange rate; international finance (search for similar items in EconPapers)
JEL-codes: F3 G3 G32 (search for similar items in EconPapers)
Date: 2017-11-01
New Economics Papers: this item is included in nep-ifn and nep-opm
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Citations: View citations in EconPapers (44)

Published in Journal of Financial Economics, 1, November, 2017, 126(2), pp. 270-299. ISSN: 0304-405X

Downloads: (external link)
http://eprints.lse.ac.uk/84140/ Open access version. (application/pdf)

Related works:
Journal Article: International correlation risk (2017)
Working Paper: International correlation risk (2014)
Working Paper: International correlation risk (2013)
Working Paper: International Correlation Risk (2012)
Working Paper: International Correlation Risk
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:84140

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