Emerging Markets Currency Factors and U.S. High-Frequency Macroeconomic Shocks
Alvero, A., & Eterovic, D. (2022). Emerging Markets Currency Factors and US High-Frequency Macroeconomic Shocks. The Journal of Portfolio Management.
The Journal of Portfolio Management Emerging Markets 2022, jpm.2022.1.370; DOI: https://doi.org/10.3905/jpm.2022.1.370
5 Pages Posted: 11 Aug 2021 Last revised: 20 Jun 2022
Date Written: February 28, 2022
Relying on the structural vector autoregression developed by Cieslak and Pang (2021), we identify four shocks to the U.S. economy based on the U.S. Treasury yield curve and the stock market: two fundamental news shocks (growth and money) and two risk-premium shocks (common and hedging). We find that these shocks explain over 40% of the time-series variation of emerging markets currency (EMFX) returns. Additionally, EMFX returns increase significantly with positive growth shocks and decrease with monetary tightening and risk-premium shocks. We show that growth and common shocks are priced in the cross-section of EMFX, with a positive and negative risk premia, respectively. We then build long-short currency portfolios based on several academically researched style factors and test their performance and relative exposure to the macroeconomic shocks affecting the U.S. economy. We find that only Carry and Macro Momentum long-short portfolios generate positive and significant alphas and excess returns over our sample. However, all single-factor portfolios have sizable exposure to the four shocks. We show that a simple multifactor approach to investing in EMFXs eliminates the exposure of excess returns to all macroeconomic shocks.
Keywords: High-frequency shocks, emerging markets currencies, factor investing
JEL Classification: G11, G12, G15, E44
Suggested Citation: Suggested Citation