The Quanto Theory of Exchange Rates

Kremens, Lukas; Martin, Ian

doi:10.2139/ssrn.2952250

Cited by 5 publications

(5 citation statements)

References 32 publications

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“…More generally, a number of papers have made progress on the exchange rate disconnect puzzle. Gourinchas and Rey (2007) show predictability over medium term horizons using the cyclical component of net external balances, and Kremens and Martin (2018) have success forecasting exchange rates with S&P 500 options-implied risk premia. Measures of the convenience yield on treasuries have been shown to covary with the broad dollar exchange rate in Jiang et al (2018) and Engel and Wu (2018).…”

mentioning

confidence: 99%

Exchange Rate Reconnect

Lilley¹,

Maggiori

Neiman

et al. 2022

The Review of Economics and Statistics

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It is surprisingly difficult to find economic variables that strongly co-move with exchange rates, a phenomenon codified in a large literature on “exchange rate disconnect.” We demonstrate that a variety of common proxies for global risk appetite, which did not co-move with exchange rates prior to 2007, have provided significant in-sample explanatory power for currencies since then. Furthermore, during 2007-2012, U.S. purchases of foreign bonds were highly correlated with these risk measures and with exchange rates. Our results support the narrative that the US dollar's role as an international and safe-haven currency has surged since the global financial crisis.

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confidence: 99%

Exchange Rate Reconnect

Lilley¹,

Maggiori

Neiman

et al. 2022

The Review of Economics and Statistics

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“…Our results document that a business cycle risk factor is priced in the cross-section of currency excess returns and that the factor can be rationalized in terms of an international macro-finance 6 model with long-run risk as in Colacito and Croce (2011), Bansal and Shaliastovich (2012), Lustig and Richmond (2019), and Kremens and Martin (2019). The model abstracts away from trade in the consumption goods' market and delivers closed form solutions for most equilibrium objects of interest.…”

Section: Related Literaturementioning

confidence: 64%

“…In this section we present a simple model that can generate a risk premium associated with relative output gaps across countries, the GAP premium. While this setup abstracts away from trade in the consumption goods market, it constitutes a useful benchmark in the international finance literature, and it has been applied to the analysis of exchange rates' volatility (Colacito and Croce, 2011), international term structure of interest rates (Bansal and Shaliastovich, 2012), gravity in exchange rates' fluctuations (Lustig and Richmond, 2019), and quanto contracts (Kremens and Martin, 2019). We follow the literature and focus on this setup due to its ability to deliver closed form solutions for all the objects of interest, and leave a fully fledged general equilibrium analysis to future research.…”

Section: A Model For the Gap Premiummentioning

confidence: 99%

Business Cycles and Currency Returns

Colacito

Riddiough

Sarno

2019

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We find a strong link between currency excess returns and the relative strength of the business cycle. Buying currencies of strong economies and selling currencies of weak economies generates high returns both in the cross section and time series of countries. These returns stem primarily from spot exchange rate predictability, are uncorrelated with common currency investment strategies, and cannot be understood using traditional currency risk factors in either unconditional or conditional asset pricing tests. We also show that a business cycle factor implied by our results is priced in a broad currency cross section.

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“…The second term reflects the pricing of the Twin Ds risk. Kremens and Martin (2019) refer to the covariance term as the quanto-implied FX risk premium.…”

Section: Notation and Basic Relationsmentioning

confidence: 99%

Sovereign Credit and Exchange Rate Risks: Evidence from Asia-Pacific Local Currency Bonds

Chernov¹,

Creal²,

Hördahl³

2020

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BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS.This publication is available on the BIS website (www.bis.org).

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The Quanto Theory of Exchange Rates

Cited by 5 publications

References 32 publications

Exchange Rate Reconnect

Exchange Rate Reconnect

Business Cycles and Currency Returns

Sovereign Credit and Exchange Rate Risks: Evidence from Asia-Pacific Local Currency Bonds

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