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FX correlation trading: theory and practice

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  • Jonathan Shomroni

    (Reichman University (Interdisciplinary Center Herzliya))

Abstract

We undertake an asset-pricing approach to provide a comprehensive analysis of the theoretical background that allows the synthetic construction of FX correlation structured products. We compare FX to equity indices correlation theory and review some of the literature on equity and FX correlation theory and empirics. We then present our own novel analysis of FX correlation time series, both realized-historical and market-implied, and test for predictability, for model-fits and for the presence and behavior of correlation risk premium. We conclude our discussion with some more comments about the theory and practice of FX correlation markets, describing the replication of non-interlinked FX crosses’ correlation claims and reviewing the data and possible trading opportunities of emerging markets’ currency correlation markets.

Suggested Citation

  • Jonathan Shomroni, 2022. "FX correlation trading: theory and practice," SN Business & Economics, Springer, vol. 2(9), pages 1-28, September.
    • Handle: RePEc:spr:snbeco:v:2:y:2022:i:9:d:10.1007_s43546-022-00304-4
    DOI: 10.1007/s43546-022-00304-4
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    References listed on IDEAS

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    1. Campa, Jose Manuel & Chang, P. H. Kevin, 1998. "The forecasting ability of correlations implied in foreign exchange options," Journal of International Money and Finance, Elsevier, vol. 17(6), pages 855-880, December.
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    3. Longin, Francois & Solnik, Bruno, 1995. "Is the correlation in international equity returns constant: 1960-1990?," Journal of International Money and Finance, Elsevier, vol. 14(1), pages 3-26, February.
    4. Pavel V. Shevchenko, 2009. "Implied Correlation for Pricing multi-FX options," Papers 0904.4822, arXiv.org.
    5. François Longin & Bruno Solnik, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, April.
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