FX Comovements: Disentangling the Role of Market Factors, Carry-Trades and Idiosyncratic Components

32 Pages Posted: 8 Jun 2011

See all articles by Jose Gonzalo Rangel

Jose Gonzalo Rangel

Goldman Sachs Group, Inc. - Global Investment Research

Date Written: March 10, 2011

Abstract

This paper models high and low frequency dynamic components of FX excess return correlations and examines their relationship with economic fundamentals. A factor currency pricing model is used to characterize the correlation structure of FX excess returns. I provide evidence on high levels of comovement in FX markets during the post-crisis (or recovery) period following the 2008 financial turmoil. I find that while the low frequency component of systematic volatility shows an increasing trend during this recent period, the low frequency component of idiosyncratic volatilities presents declining patterns. These two effects explain the increase in average long-term correlations. In terms of idiosyncratic effects, my results suggest that country-specific inflation levels and real output growth significantly affect the time-series and cross-sectional variation of long-term FX idiosyncratic volatilities.

Keywords: Comovements, FX Markets, Global Factors, Idiosyncratic Volatilities, Fundamentals

JEL Classification: F31, G12, G15

Suggested Citation

Rangel, Jose Gonzalo, FX Comovements: Disentangling the Role of Market Factors, Carry-Trades and Idiosyncratic Components (March 10, 2011). Available at SSRN: https://ssrn.com/abstract=1858477 or http://dx.doi.org/10.2139/ssrn.1858477

Jose Gonzalo Rangel (Contact Author)

Goldman Sachs Group, Inc. - Global Investment Research ( email )

200 West Street
New York, NY 10280
United States

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