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The quanto theory of exchange rates

Lukas Kremens () and Ian Martin ()

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

Abstract: We present a new identity that relates expected exchange rate appreciation to a risk-neutral covariance term, and use it to motivate a currency forecasting variable based on the prices of quanto index contracts. We show via panel regressions that the quanto forecast variable is an economically and statistically significant predictor of currency appreciation and of excess returns on currency trades. Out of sample, the quanto variable outperforms predictions based on uncovered interest parity, on purchasing power parity, and on a random walk as a forecaster of differential (dollar-neutral) currency appreciation.

JEL-codes: F31 F37 F47 G12 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-for, nep-mon and nep-opm
Date: 2019-03-01
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Published in American Economic Review, 1, March, 2019, 109(3), pp. 810-843. ISSN: 0002-8282

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http://eprints.lse.ac.uk/89839/ Open access version. (application/pdf)

Related works:
Journal Article: The Quanto Theory of Exchange Rates (2019) Downloads
Working Paper: The Quanto Theory of Exchange Rates (2017) Downloads
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