The Global Factor Structure of Exchange Rates

83 Pages Posted: 14 Oct 2020 Last revised: 28 Oct 2021

See all articles by Sofonias Alemu Korsaye

Sofonias Alemu Korsaye

Swiss Finance Institute; University of Geneva - Geneva Finance Research Institute (GFRI)

Fabio Trojani

University of Geneva; University of Turin - Department of Statistics and Applied Mathematics; Swiss Finance Institute

Andrea Vedolin

Boston University - Department of Finance & Economics

Multiple version iconThere are 3 versions of this paper

Date Written: October 26, 2021

Abstract

We propose a model-free methodology to estimate international stochastic discount factors (SDFs) that jointly price cross-sections of international stocks, bonds, and currencies in markets with frictions, and study the global factor structure of exchange rates. We theoretically establish a SDF decomposition into one global factor and a currency basket. We show that our global factor prices a large cross-section of international asset returns not just in- but also out-of-sample across different currency denominations. Moreover, the pricing ability of the global factor is largely independent of the market structure or the size and type of market friction.

Keywords: International asset pricing, stochastic discount factor, factor models, financial frictions, market segmentation, incomplete markets, capital flows

JEL Classification: F31, G15

Suggested Citation

Korsaye, Sofonias Alemu and Trojani, Fabio and Vedolin, Andrea, The Global Factor Structure of Exchange Rates (October 26, 2021). Swiss Finance Institute Research Paper No. 20-107, Proceedings of Paris December 2020 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3698387 or http://dx.doi.org/10.2139/ssrn.3698387

Sofonias Alemu Korsaye

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

Fabio Trojani

University of Geneva ( email )

Geneva, Geneva
Switzerland

University of Turin - Department of Statistics and Applied Mathematics ( email )

Piazza Arbarello, 8
Turin, I-10122
Italy

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Andrea Vedolin (Contact Author)

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

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