The Global Factor Structure of Exchange Rates

54 Pages Posted: 3 Nov 2020

See all articles by Sofonias A. Korsaye

Sofonias A. Korsaye

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute

Fabio Trojani

Swiss Finance Institute; University of Geneva

Andrea Vedolin

Boston University - Department of Finance & Economics

Multiple version iconThere are 3 versions of this paper

Date Written: October 1, 2020

Abstract

We provide a model-free framework to study the global factor structure of exchange rates. To this end, we propose a new methodology to estimate international stochastic discount factors (SDFs) that jointly price cross-sections of international assets, such as stocks, bonds, and currencies, in the presence of frictions. We theoretically establish a two-factor representation for the crosssection of international SDFs, consisting of one global and one local factor, which is independent of the currency denomination. We show that our two-factor specification prices a large crosssection of international asset returns, not just in- but also out-of-sample with R2s of up to 80%.

Keywords: Capital Flows, factor models, Financial Frictions, incomplete markets, International Asset Pricing, Lasso, Market Segmentation, regularization, Stochastic discount factor

JEL Classification: F31, G15

Suggested Citation

Korsaye, Sofonias A. and Trojani, Fabio and Vedolin, Andrea, The Global Factor Structure of Exchange Rates (October 1, 2020). CEPR Discussion Paper No. DP15337, Available at SSRN: https://ssrn.com/abstract=3723526

Sofonias A. Korsaye (Contact Author)

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Fabio Trojani

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of Geneva ( email )

Geneva, Geneva
Switzerland

Andrea Vedolin

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

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