IDEAS home Printed from https://ideas.repec.org/p/ecl/stabus/3410.html
   My bibliography  Save this paper

Gravity in FX R^{2}: Understanding the Factor Structure in Exchange Rates

Author

Listed:
  • Lustig, Hanno

    (Stanford University)

  • Richmond, Robert J.

    (UCLA)

Abstract

Exchange rates strongly co-vary against their base currency. We uncover a gravity equation in this factor structure: the key determinant of a country's exchange rate beta on the common base factor is the country's distance from the base country. The farther the country, the larger the beta. For example, the beta of the CHF/USD exchange rate on the dollar factor is determined by the distance between Switzerland and the United States. Shared language, legal origin, shared border, resource similarity and colonial linkages also significantly lower the betas. On average, the exchange rates of peripheral countries tend to have high Rsquareds in factor regressions, while central countries have low Rsquareds. A no-arbitrage model of exchange rates replicates this distance-dependent factor structure when the exposure of pricing kernels to global risk factors is more similar for closer country pairs.

Suggested Citation

  • Lustig, Hanno & Richmond, Robert J., 2015. "Gravity in FX R^{2}: Understanding the Factor Structure in Exchange Rates," Research Papers 3410, Stanford University, Graduate School of Business.
    • Handle: RePEc:ecl:stabus:3410
    as

    Download full text from publisher

    File URL: http://www.gsb.stanford.edu/gsb-cmis/gsb-cmis-download-auth/415326
    Download Restriction: no
    ---><---

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ecl:stabus:3410. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/gsstaus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.