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A universal exponent governing foreign exchange rate risks

Author

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  • Grobys, Klaus

Abstract

Departing from previous studies, this paper uses power laws to model foreign exchange rate risks in terms of realized foreign exchange rate (FX) variances for daily and weekly data. Empirical tests based on daily data provide strong evidence for emergent market risk behavior manifested in a common power-law exponent governing the cross section of realized FX variances. We show that this emergent market risk behavior is invariant across various time frequencies. Based on modern bootstrapping techniques, we derive a novel joint test for investigating the presence of total invariance—that is, invariance of emergent market risk behavior across time frequencies and over time. Our novel test provides strong evidence for total invariance of realized FX variances. We argue that the results are in line with the theory of complex systems—that is, even though FX risk exhibits idiosyncratic features that may originate from market-distinct factors (inflation, interest rates, public debts, etc.), emergent market behavior manifests itself in a universal power-law exponent governing the cross section of FX risks.

Suggested Citation

  • Grobys, Klaus, 2024. "A universal exponent governing foreign exchange rate risks," International Review of Financial Analysis, Elsevier, vol. 95(PB).
    • Handle: RePEc:eee:finana:v:95:y:2024:i:pb:s1057521924003545
    DOI: 10.1016/j.irfa.2024.103422
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    More about this item

    Keywords

    Foreign exchange rates; Pareto distributions; Power laws; Second moment; Variance;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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