FX Comovements and their Economic Determinants

61 Pages Posted: 8 Jun 2011 Last revised: 16 Nov 2021

Date Written: July 19, 2021

Abstract

This paper models high and low frequency dynamic components of FX excess return correlations and examines their relationship with economic fundamentals. A factor pricing model with time-varying betas driven by economic variables is used to characterize the correlation structure of currency excess returns. From the low frequency components, an aggregate FX comovement measure is derived. This component is countercyclical relative to the U.S. (base country), as it is negatively related to economic growth and positively related to both inflation volatility and economic policy uncertainty. Across currency pairs, variation in idiosyncratic volatilities also drives dynamic patterns in currency comovements. I provide evidence that country-specific inflation levels, monetary policy variables, as well as trade and capital flows, have significant impacts on FX idiosyncratic volatilities, while real output growth shows significant effects only for emerging markets.

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

JEL Classification: F31, G12, G15

Suggested Citation

Rangel, Jose Gonzalo, FX Comovements and their Economic Determinants (July 19, 2021). Available at SSRN: https://ssrn.com/abstract=1858477 or http://dx.doi.org/10.2139/ssrn.1858477

Jose Gonzalo Rangel (Contact Author)

Banorte Financial Group

Prol. Reforma 1230
Mexico City, CDMX 05349
Mexico

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