The Global Factor Structure of Exchange Rates

53 Pages Posted: 14 Oct 2020 Last revised: 21 Dec 2020

See all articles by Sofonias A. Korsaye

Sofonias A. Korsaye

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

Fabio Trojani

Swiss Finance Institute; University of Geneva

Andrea Vedolin

Boston University - Department of Finance & Economics

Multiple version iconThere are 3 versions of this paper

Date Written: September 23, 2020

Abstract

We provide a model-free framework to study the global factor structure of exchange rates. To this end, we propose a new methodology to estimate international stochastic discount factors (SDFs) that jointly price cross-sections of international assets, such as stocks, bonds, and currencies, in the presence of frictions. We theoretically establish a two-factor representation for the cross-section of international SDFs, consisting of one global and one local factor, which is independent of the currency denomination. We show that our two-factor specification prices a large cross-section of international asset returns, not just in- but also out-of-sample with R2s of up to 80%.

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

JEL Classification: F31, G15

Suggested Citation

Korsaye, Sofonias A. and Trojani, Fabio and Vedolin, Andrea, The Global Factor Structure of Exchange Rates (September 23, 2020). 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 A. Korsaye

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

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

Swiss Finance Institute ( email )

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

Fabio Trojani

Swiss Finance Institute ( email )

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

University of Geneva ( email )

Geneva, Geneva
Switzerland

Andrea Vedolin (Contact Author)

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

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