What Do Stock Markets Tell Us About Exchange Rates?

75 Pages Posted: 19 Jul 2014 Last revised: 4 Jul 2015

See all articles by Gino Cenedese

Gino Cenedese

Fulcrum Asset Management

Richard Payne

City University London - Sir John Cass Business School

Lucio Sarno

University of Cambridge - Judge Business School; Centre for Economic Policy Research (CEPR)

Giorgio Valente

Hong Kong Institute for Monetary and Financial Research (HKIMR)

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Date Written: July 3, 2015

Abstract

The sign of the correlation between equity returns and exchange rate returns can be positive or negative in theory. Using data for a broad set of 42 countries, we find that exchange rate movements are in fact unrelated to differentials in country-level equity returns. Consequently, a trading strategy that invests in countries with the highest expected equity returns and shorts those with the lowest generates substantial returns and Sharpe ratios. These returns partially reflect compensation for global equity volatility risk, but significant excess returns remain after controlling for exposure to standard risk factors.

Keywords: Empirical Asset Pricing, Exchange Rates, Uncovered Equity Parity, International Asset Allocation

JEL Classification: F31, G15

Suggested Citation

Cenedese, Gino and Payne, Richard G. and Sarno, Lucio and Valente, Giorgio, What Do Stock Markets Tell Us About Exchange Rates? (July 3, 2015). Available at SSRN: https://ssrn.com/abstract=2467707 or http://dx.doi.org/10.2139/ssrn.2467707

Gino Cenedese

Fulcrum Asset Management ( email )

66 Seymour Street
London, W1H 5BT
United Kingdom

Richard G. Payne (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Lucio Sarno

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Giorgio Valente

Hong Kong Institute for Monetary and Financial Research (HKIMR) ( email )

One Pacific Place, 10th Floor
88 Queensway
Hong Kong
China

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