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The Share of Systematic Variation in Bilateral Exchange Rates

54 Pages Posted: 19 Sep 2011 Last revised: 30 Oct 2015

Adrien Verdelhan

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: July 1, 2015

Abstract

Sorting countries by their dollar currency betas produces a novel cross-section of average currency excess returns. A slope factor (long in high beta currencies and short in low beta currencies) accounts for this cross-section of currency risk premia. This slope factor is orthogonal to the high-minus-low carry trade factor built from portfolios of countries sorted by their interest rates. The two high-minus-low risk factors account for 18% to 80% of the monthly exchange rate movements. The two risk factors suggest that stochastic discount factors in complete markets' models should feature at least two global shocks to describe exchange rates.

Keywords: exchange rates, forward premium puzzle, risk premium

JEL Classification: F31

Suggested Citation

Verdelhan, Adrien, The Share of Systematic Variation in Bilateral Exchange Rates (July 1, 2015). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1930516 or http://dx.doi.org/10.2139/ssrn.1930516

Adrien Verdelhan (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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