Benchmark Currency Stochastic Discount Factors

72 Pages Posted: 19 Oct 2021 Last revised: 5 Nov 2021

See all articles by Piotr Orłowski

Piotr Orłowski

HEC Montréal; CDI

Valeri Sokolovski

University of Alberta

Erik Sverdrup

Stanford University

Date Written: October 18, 2021


We examine the pricing performance of out-of-sample pricing factors in the broad cross-section of currency returns. To this end, we develop a methodology for estimating empirical minimum-dispersion stochastic discount factors (SDFs) under constraints on maximum position leverage. Under leverage constraints compatible with those observed in the currency markets, our empirical SDFs deliver smaller out-of-sample pricing errors than existing factor models, and are priced in individual currency and hedge fund cross-sections. After transaction costs, an investable SDF portfolio delivers a Sharpe ratio of around 0.8 and positively skewed returns. These empirical SDFs offer tractable benchmarks for candidate currency pricing models.

Keywords: FX risk premium, FX hedge funds, leverage, machine learning, SDF.

JEL Classification: F31, G12, G15

Suggested Citation

Orłowski, Piotr and Sokolovski, Valeri and Sverdrup, Erik, Benchmark Currency Stochastic Discount Factors (October 18, 2021). Available at SSRN: or

Piotr Orłowski

HEC Montréal ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7

CDI ( email )

3000, chemin de la Côte-Sainte-Catherine
Montréal, Québec H3T 2A7

Valeri Sokolovski (Contact Author)

University of Alberta ( email )

Edmonton, Alberta T6G 2R3

Erik Sverdrup

Stanford University ( email )

Stanford, CA 94305
United States

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