The Quanto Theory of Exchange Rates

50 Pages Posted: 25 Apr 2017

See all articles by Lukas Kremens

Lukas Kremens

University of Washington

Ian Martin

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

Multiple version iconThere are 2 versions of this paper

Date Written: April 2017

Abstract

We present a new, theoretically motivated, forecasting variable for exchange rates that is based on the prices of quanto index contracts, and show via panel regressions that the quanto forecast variable is a statistically and economically significant predictor of currency appreciation. We also test the quanto variable's ability to forecast differential currency appreciation out of sample, and find that it outperforms predictions based on uncovered interest parity, on purchasing power parity, and on a random walk.

Keywords: carry trade, currency, Exchange rate, exchange rate forecast, Forecasting, predictability, quanto contracts

JEL Classification: F31, F37, F47, G12, G15

Suggested Citation

Kremens, Lukas and Martin, Ian W. R., The Quanto Theory of Exchange Rates (April 2017). CEPR Discussion Paper No. DP11970, Available at SSRN: https://ssrn.com/abstract=2957509

Lukas Kremens (Contact Author)

University of Washington ( email )

WA
United States

Ian W. R. Martin

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

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/martiniw/

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