Dollar and Carry Redux

68 Pages Posted: 13 Jul 2022 Last revised: 21 Nov 2023

See all articles by Sining Liu

Sining Liu

The University of Hong Kong; Washington University in St. Louis; Renmin University of China

Thomas Andreas Maurer

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

Andrea Vedolin

Boston University - Department of Finance & Economics

Yaoyuan Zhang

HKU Business School

Date Written: July 1, 2022

Abstract

Contrary to existing literature, we establish that two factors, dollar and carry, suffice to explain a large cross-section of currency returns with R2s exceeding 80%. Our paper highlights the importance of accounting for time-variation in conditional moments. Unconditional estimations that ignore this time-variation mistakenly reject the two-factor model. We propose a parsimonious framework to estimate conditional currency factor models and provide testable restrictions. Our findings imply that currency markets are well described by a model in which (i) each country-specific SDF loads on one country-specific—dollar—and one global—carry shock, and (ii) risk loadings are time-varying. Other risk factors proposed in the literature are useful to describe the time variation in dollar and carry factor risk premia.

Keywords: Foreign Exchange, Dollar, Carry, Conditional, Factor, Pricing Model

JEL Classification: F31, G12, G15

Suggested Citation

Liu, Sining and Maurer, Thomas Andreas and Vedolin, Andrea and Zhang, Yaoyuan, Dollar and Carry Redux (July 1, 2022). Available at SSRN: https://ssrn.com/abstract=4150881 or http://dx.doi.org/10.2139/ssrn.4150881

Sining Liu

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1208
Saint Louis, MO MO 63130-4899
United States

Renmin University of China ( email )

Room B906
Xianjin Building
Beijing, Beijing 100872
China

Thomas Andreas Maurer (Contact Author)

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
Hong Kong

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

Andrea Vedolin

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Yaoyuan Zhang

HKU Business School ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

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