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Pricing Currency Risks

Author

Listed:
  • Mikhail Chernov
  • Magnus Dahlquist
  • Lars A. Lochstoer

Abstract

The currency market features a relatively small cross-section and conditional expected returns can be characterized by only a few signals – interest differentials, trend, and mean-reversion. We exploit these properties to construct a conditional projection of the stochastic discount factor onto excess returns of individual currencies. Our approach is implementable in real time and prices all currencies and prominent strategies conditionally as well as unconditionally. We document that the fraction of unpriced risk in these assets is at least 85%. Extant explanations of carry strategies based on intermediary capital or global volatility are related to these unpriced components, while consumption growth is related to the priced component of returns.

Suggested Citation

  • Mikhail Chernov & Magnus Dahlquist & Lars A. Lochstoer, 2020. "Pricing Currency Risks," NBER Working Papers 28260, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:28260
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    Cited by:

    1. Naveed, Hafiz Muhammad & Pan, Yanchun & Yao, HongXing & Al-Faryan, Mamdouh Abdulaziz Saleh, 2024. "Assessing the nexus between currency exchange rate returns, currency risk hedging and international investments: Intelligent network-based analysis," Technological Forecasting and Social Change, Elsevier, vol. 206(C).
    2. Hassan, Ramin & Loualiche, Erik & Pecora, Alexandre R. & Ward, Colin, 2023. "International trade and the risk in bilateral exchange rates," Journal of Financial Economics, Elsevier, vol. 150(2).
    3. Filippou, Ilias & Maurer, Thomas A. & Pezzo, Luca & Taylor, Mark P., 2024. "Importance of transaction costs for asset allocation in foreign exchange markets," Journal of Financial Economics, Elsevier, vol. 159(C).

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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