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The Global Factor Structure of Exchange Rates

Author

Listed:
  • Sofonias Korsaye
  • Fabio Trojani
  • Andrea Vedolin

Abstract

We provide a model-free framework to study the global factor structure of exchange rates. To this end, we propose a new methodology to estimate international stochastic discount factors (SDFs) that jointly price cross-sections of international assets, such as stocks, bonds, and currencies, in the presence of frictions. We theoretically establish a two-factor representation for the cross-section of international SDFs, consisting of one global and one local factor, which is independent of the currency denomination. We show that our two-factor specification prices a large cross-section of international asset returns, not just in- but also out-of-sample with R2s of up to 80%.

Suggested Citation

  • Sofonias Korsaye & Fabio Trojani & Andrea Vedolin, 2020. "The Global Factor Structure of Exchange Rates," NBER Working Papers 27892, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:27892
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    Cited by:

    1. Granziera, Eleonora & Sihvonen, Markus, 2024. "Bonds, currencies and expectational errors," Journal of Economic Dynamics and Control, Elsevier, vol. 158(C).
    2. Fredy Gamboa-Estrada & José Vicente Romero, 2022. "Common and idiosyncratic movements in Latin-American exchange rates," International Economics, CEPII research center, issue 171, pages 174-190.
    3. Mikhail Chernov & Magnus Dahlquist & Lars Lochstoer, 2023. "Pricing Currency Risks," Journal of Finance, American Finance Association, vol. 78(2), pages 693-730, April.
    4. Branger, Nicole & Herold, Michael & Muck, Matthias, 2021. "International stochastic discount factors and covariance risk," Journal of Banking & Finance, Elsevier, vol. 123(C).
    5. Jiang, Zhengyang & Richmond, Robert J., 2023. "Origins of international factor structures," Journal of Financial Economics, Elsevier, vol. 147(1), pages 1-26.

    More about this item

    JEL classification:

    • F3 - International Economics - - International Finance
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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