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Common risk factors in cross-sectional FX options returns

Author

Listed:
  • Xuanchen Zhang
  • Raymond H Y So
  • Tarik Driouchi

Abstract

We identify a comprehensive list of thirty-eight characteristics for predicting cross-sectional FX options returns. We find that three factors—long-term straddle momentum, implied volatility, and illiquidity—can generate economically and statistically significant risk premia not explained by other return predictors. Meanwhile, the predictability of the other characteristics becomes insignificant after accounting for the FX option three-factor model. The significance of the three factors is confirmed through a series of robustness tests covering different data sources, alternative options strategies, diversification effects, bootstrapping, and omitting crisis years.

Suggested Citation

  • Xuanchen Zhang & Raymond H Y So & Tarik Driouchi, 2024. "Common risk factors in cross-sectional FX options returns," Review of Finance, European Finance Association, vol. 28(3), pages 897-944.
  • Handle: RePEc:oup:revfin:v:28:y:2024:i:3:p:897-944.
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    File URL: http://hdl.handle.net/10.1093/rof/rfae002
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    Keywords

    options returns; implied volatility; momentum; illiquidity; FX options; foreign exchange;
    All these keywords.

    JEL classification:

    • 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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