Identifying Portfolio-Based Risk Factors in Foreign Exchange Markets
24 Pages Posted: 27 Feb 2018
Date Written: February 27, 2018
This paper shows that a link between the conditional mean and conditional volatility of any factor-mimicking portfolio in the foreign exchange (FX) market must exist if the proposed portfolio-based currency factor is priced and the pricing kernel has a linear factor structure. Thereby, this paper tests whether the carry risk factor and currency momentum are priced risk factors. Surprisingly, the carry risk factor does not meet the necessary conditions consistent with being a priced risk factor, whereas currency momentum indeed meets those criteria. The findings also indicate that the relation between the conditional mean and conditional risk is moreover economically reasonable for the currency momentum portfolio.
Keywords: Asset Pricing, Carry Risk Factor, Currency Momentum, Foreign Exchange Market
JEL Classification: G12, G14
Suggested Citation: Suggested Citation