Emerging Market Currency Excess Returns

Abstract

This is a descriptive paper on the excess return from 20 internationally tradable emerging market (EM) currencies. It has two contributions. First, we document stylized facts about EM currencies. For the period starting in the second half of the 1990s and including the two major crises (the 1997 East Asian crisis and the recent Lehman shock), we find that the basket of EM currencies has provided significant equity-like excess returns against major currencies, but with low volatility. After confirming that the forward premium puzzle is less prevalent for EM currencies than for major currencies, we find that the forward premium for majors, rather than that for EM currencies, is a better predictor of the EM excess return. Second, our calculation takes into account institutional features of the foreign exchange market such as bid/offer spreads, FX (foreign exchange) swaps, and lags in settling spot contracts.

Keywords: Emerging Market Currencies, Risk Premium, Bid/Offer Spreads, FX Swaps

JEL Classification: F31, G11, G15