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The quanto theory of exchange rates

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  • Kremens, Lukas
  • Martin, Ian

Abstract

We present a new, theoretically motivated, forecasting variable for exchange rates that is based on the prices of quanto index contracts, and show via panel regressions that the quanto forecast variable is a statistically and economically significant predictor of currency appreciation and of excess returns on currency trades. We also test the quanto variable's ability to forecast differential currency appreciation out of sample, and find that it outperforms predictions based on uncovered interest parity, on purchasing power parity, and on a random walk.

Suggested Citation

  • Kremens, Lukas & Martin, Ian, 2017. "The quanto theory of exchange rates," LSE Research Online Documents on Economics 118961, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:118961
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    File URL: http://eprints.lse.ac.uk/118961/
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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