Currency Factors

58 Pages Posted: 23 Aug 2017 Last revised: 8 Feb 2019

See all articles by Arash Aloosh

Arash Aloosh

Neoma Business School

Geert Bekaert

Columbia Business School - Finance and Economics

Multiple version iconThere are 3 versions of this paper

Date Written: February 6, 2019

Abstract

We examine the ability of existing and new factor models to explain the comovements of G10-currency changes, measured using the novel concept of “currency baskets”, representing the overall movement of a particular currency. Using a clustering technique, we find a clear two-block structure in currency comovements with the first block containing mostly the dollar currencies, and the other the European currencies. A factor model incorporating this “clustering” factor and two additional factors, a commodity currency factor and a “world” factor based on trading volumes, fits currency basket correlations much better than extant factors, such as value and carry, do. In particular, it explains on average about 60% of currency variation and generates a root mean squared error relative to sample correlations of only 0.11. The model also fits comovements in emerging market currencies well. Economically, the correlations between currency baskets underlying the factor structure are inversely related to the physical distances between countries. The factor structure is also related to the exposure of the corresponding pricing kernels with respect to the global pricing kernel and is apparent in cross-country retail sales growth data.

Keywords: Currency Factors; Currency Comovements; Clustering; Factor Models; Currency Baskets; Global Pricing Kernels.

JEL Classification: F31, G12

Suggested Citation

Aloosh, Arash and Bekaert, Geert, Currency Factors (February 6, 2019). Columbia Business School Research Paper No. 17-88. Available at SSRN: https://ssrn.com/abstract=3022623 or http://dx.doi.org/10.2139/ssrn.3022623

Arash Aloosh

Neoma Business School ( email )

1 Rue du Maréchal Juin,
Mont Saint Aignan, 76130
France
+33232824736 (Phone)

Geert Bekaert (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

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