Pricing Currency Risks

57 Pages Posted: 23 Dec 2020 Last revised: 11 Feb 2021

See all articles by Mikhail Chernov

Mikhail Chernov

UCLA Anderson

Magnus Dahlquist

Stockholm School of Economics; Swedish House of Finance

Lars A. Lochstoer

University of California, Los Angeles (UCLA) - Anderson School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: December 2020

Abstract

The currency market features a relatively small cross-section and conditional expected returns can be characterized by only a few signals â?? 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.

JEL Classification: F31, G12, G15

Suggested Citation

Chernov, Mikhail and Dahlquist, Magnus and Lochstoer, Lars A., Pricing Currency Risks (December 2020). CEPR Discussion Paper No. DP15571, Available at SSRN: https://ssrn.com/abstract=3753971

Mikhail Chernov (Contact Author)

UCLA Anderson ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Magnus Dahlquist

Stockholm School of Economics ( email )

Drottninggatan 98
Stockholm, SE-111 60
Sweden

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Lars A. Lochstoer

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

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