Forward-Looking Currency Betas

58 Pages Posted: 27 Nov 2017 Last revised: 24 Jun 2018

Date Written: April 20, 2018

Abstract

I propose a model-free method to derive forward-looking betas to currency portfolios from cross-pair currency options. Using the dollar factor --- an equal-weighted basket of foreign currencies against the U.S. dollar --- as the systematic factor, I find that these option-implied betas are significantly better predictors of realized betas and currency excess returns compared to traditional rolling window betas. Constructing portfolios based on option-implied betas leads to a significantly positive relation between ex-ante betas and ex-post portfolio returns, whereas there is an insignificant relation when rolling window betas are used.

Keywords: Exchange rate risk premiums, factor models, currency options, option-implied betas, foreign exchange volatility

JEL Classification: G12, G15, F31

Suggested Citation

Bang Nielsen, Andreas, Forward-Looking Currency Betas (April 20, 2018). Available at SSRN: https://ssrn.com/abstract=3076009 or http://dx.doi.org/10.2139/ssrn.3076009

Andreas Bang Nielsen (Contact Author)

Cornerstone Research ( email )

4 More London Riverside
London, SE1 2AU
United Kingdom

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