Pricing Implications of Covariances and Spreads in Currency Markets

73 Pages Posted: 26 Apr 2018 Last revised: 25 Oct 2018

See all articles by Thomas Andreas Maurer

Thomas Andreas Maurer

Washington University in St. Louis - John M. Olin Business School; London School of Economics & Political Science (LSE)

Thuy Duong To

University of New South Wales, Sydney; Financial Research Network (FIRN)

Ngoc-Khanh Tran

Pamplin College of Business - Virginia Tech

Date Written: October 23, 2018

Abstract

We introduce a covariance and spread (i.e., exchange rate forward discount) adjusted carry factor that prices the cross-section of FX market returns, where many other single and multi-factor models fail. Both the covariance matrix of exchange rate growths and forward discounts contain important information for pricing, which is not captured by well-known factors. The conditional covariance matrix and forward discounts are time-varying and forecast future realized currency returns.

Keywords: Foreign Exchange, Carry, Forward Discount, Spread Adjustment, Covariance Adjustment, Mean-Variance, Factor Pricing Model, Predictability

JEL Classification: F31, F37, G12, G15, G17

Suggested Citation

Maurer, Thomas Andreas and To, Thuy Duong and Tran, Ngoc-Khanh, Pricing Implications of Covariances and Spreads in Currency Markets (October 23, 2018). Available at SSRN: https://ssrn.com/abstract=3166997 or http://dx.doi.org/10.2139/ssrn.3166997

Thomas Andreas Maurer (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Thuy Duong To

University of New South Wales, Sydney ( email )

School of Banking and Finance,
University of New South Wales
Sydney, 2052
Australia
61295855865 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Ngoc-Khanh Tran

Pamplin College of Business - Virginia Tech ( email )

Pamplin 2126
880 West Campus Drive
Blacksburg, VA 24061
United States

HOME PAGE: http://https://www.nktran.com/

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