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What Do Stock Markets Tell Us About Exchange Rates?

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  • Cenedese, Gino
  • Payne, Richard
  • Sarno, Lucio
  • Valente, Giorgio

Abstract

The sign of the correlation between equity returns and exchange rate returns can be positive or negative in theory. Using data for a broad set of 42 countries, we find that exchange rate movements are in fact unrelated to differentials in country-level equity returns. Consequently, a trading strategy that invests in countries with the highest expected equity returns and shorts those with the lowest generates substantial returns and Sharpe ratios. These returns partially reflect compensation for global equity volatility risk, but significant excess returns remain after controlling for exposure to standard risk factors.

Suggested Citation

  • Cenedese, Gino & Payne, Richard & Sarno, Lucio & Valente, Giorgio, 2015. "What Do Stock Markets Tell Us About Exchange Rates?," CEPR Discussion Papers 10685, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:10685
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    Cited by:

    1. repec:bis:bisbps:95 is not listed on IDEAS
    2. Cenedese, Gino & Mallucci, Enrico, 2016. "What moves international stock and bond markets?," Journal of International Money and Finance, Elsevier, vol. 60(C), pages 94-113.
    3. Ruipeng Liu & Riza Demirer & Rangan Gupta & Mark E. Wohar, 2017. "Do Bivariate Multifractal Models Improve Volatility Forecasting in Financial Time Series? An Application to Foreign Exchange and Stock Markets," Working Papers 201728, University of Pretoria, Department of Economics.
    4. repec:bla:reviec:v:25:y:2017:i:4:p:924-947 is not listed on IDEAS
    5. repec:eee:finsta:v:36:y:2018:i:c:p:346-360 is not listed on IDEAS
    6. Kuk Mo Jung, 2017. "Liquidity Risk And Time-Varying Correlation Between Equity And Currency Returns," Economic Inquiry, Western Economic Association International, vol. 55(2), pages 898-919, April.
    7. Stijn Claessens & M. Ayhan Kose, 2017. "Asset prices and macroeconomic outcomes: A survey," CAMA Working Papers 2017-76, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    8. Mariusz Kapuściński, 2017. "Monetary policy and financial asset prices in Poland," Bank i Kredyt, Narodowy Bank Polski, vol. 48(3), pages 263-294.
    9. Gideon Boako & Maurice Omane-Adjepong & Joseph Magnus Frimpong, 2016. "Stock Returns and Exchange Rate Nexus in Ghana: A Bayesian Quantile Regression Approach," South African Journal of Economics, Economic Society of South Africa, vol. 84(1), pages 149-179, March.
    10. repec:eee:riibaf:v:45:y:2018:i:c:p:233-242 is not listed on IDEAS
    11. Lu, Helen & Jacobsen, Ben, 2016. "Cross-asset return predictability: Carry trades, stocks and commodities," Journal of International Money and Finance, Elsevier, vol. 64(C), pages 62-87.

    More about this item

    Keywords

    Empirical Asset Pricing; Exchange Rates; International Asset Allocation;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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