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Pricing Implications of Covariances and Spreads in Currency Markets
[Optimal and naive diversification in currency markets]

Author

Listed:
  • Thomas Maurer
  • Thuy-Duong Tô
  • Ngoc-Khanh Tran

Abstract

We introduce a covariance and spread (i.e., exchange rate forward discount) adjusted carry factor that prices the cross-section of FX market returns, where many other single- and multifactor models fail. Both the covariance matrix of exchange rate growths and forward discounts contain important information for pricing that is not captured by well-known factors. The time-varying conditional covariance matrix and forward discounts forecast future realized currency returns. (JEL F31, F37, G12, G15, G17)

Suggested Citation

  • Thomas Maurer & Thuy-Duong Tô & Ngoc-Khanh Tran, 2022. "Pricing Implications of Covariances and Spreads in Currency Markets [Optimal and naive diversification in currency markets]," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 12(1), pages 336-388.
    • Handle: RePEc:oup:rasset:v:12:y:2022:i:1:p:336-388.
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    File URL: http://hdl.handle.net/10.1093/rapstu/raab019
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    Citations

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    Cited by:

    1. Thomas A Maurer & Thuy-Duong Tô & Ngoc-Khanh Tran, 2023. "Market Timing and Predictability in FX Markets," Review of Finance, European Finance Association, vol. 27(1), pages 223-246.
    2. Filippou, Ilias & Maurer, Thomas A. & Pezzo, Luca & Taylor, Mark P., 2024. "Importance of transaction costs for asset allocation in foreign exchange markets," Journal of Financial Economics, Elsevier, vol. 159(C).
    3. Mikhail Chernov & Magnus Dahlquist & Lars Lochstoer, 2023. "Pricing Currency Risks," Journal of Finance, American Finance Association, vol. 78(2), pages 693-730, April.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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