Currency Factors

47 Pages Posted: 23 Aug 2017 Last revised: 10 Jun 2021

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: January 31, 2021

Abstract

We examine the ability of existing and new factor models to explain the comovements of G10-currency changes, measured using “currency baskets.” A clustering technique reveals 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 online appendix can be found at: https://ssrn.com/abstract=3201860.

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

JEL Classification: F31, G12

Suggested Citation

Aloosh, Arash and Bekaert, Geert, Currency Factors (January 31, 2021). Management Science forthcoming, 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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