Forward-Looking Currency Betas
58 Pages Posted: 27 Nov 2017 Last revised: 24 Jun 2018
Date Written: April 20, 2018
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: Suggested Citation