International Correlation Risk

70 Pages Posted: 3 May 2012 Last revised: 29 Oct 2016

Philippe Mueller

London School of Economics & Political Science (LSE) - Department of Finance

Andreas Stathopoulos

University of Washington

Andrea Vedolin

London School of Economics and Political Science

Date Written: October 26, 2016

Abstract

We document that the cross-sectional dispersion of conditional FX correlation is countercyclical and that currencies that perform badly (well) during periods of high dispersion yield high (low) average excess returns. We also find a negative cross-sectional association between average FX correlations and average option-implied FX correlation risk premiums. Our findings show that while investors in spot currency markets require a positive risk premium for exposure to high-dispersion states, FX option prices are consistent with investors being compensated for the risk of low-dispersion states. To address our empirical findings, we propose a no-arbitrage model that features unspanned FX correlation risk.

Keywords: Correlation Risk, Exchange Rates, International Finance

JEL Classification: F31, G15

Suggested Citation

Mueller, Philippe and Stathopoulos, Andreas and Vedolin, Andrea, International Correlation Risk (October 26, 2016). Available at SSRN: https://ssrn.com/abstract=2049809 or http://dx.doi.org/10.2139/ssrn.2049809

Philippe Mueller

London School of Economics & Political Science (LSE) - Department of Finance ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Andreas Stathopoulos

University of Washington ( email )

Seattle, WA 98195
United States

Andrea Vedolin (Contact Author)

London School of Economics and Political Science ( email )

Department of Finance
Houghton Street
London, WC2A 2AE
United Kingdom

Paper statistics

Downloads
1,090
Rank
14,751
Abstract Views
5,477