Global Political Risk and Currency Momentum

Abstract

Using a measure of political risk, relative to the United States, that captures unexpected political conditions, we show that political risk is priced in the cross section of currency momentum and contains information beyond other risk factors. Our results are robust after controlling for transaction costs, reversals, and alternative limits to arbitrage. The global political environment affects the profitability of the momentum strategy in the foreign exchange market; investors following such strategies are compensated for the exposure to the global political risk of those currencies they hold, that is, the past winners, and exploit the lower returns of loser portfolios. The risk compensation is mainly justified by the different exposures of foreign currencies in the momentum portfolio to U.S. political shocks, which is the main component of global political risk.

İktisadi, Finansal ve Politik Risklerin Türkiye CDS Primine Etkileri

“…The data for economic, financial and political risks have been obtained from the ICRG, while the data for CDS have been obtained from the Bloomberg. Because ICRG presents comprehensive risk structure for a country with ratings for its economic, financial and political risks, most authors used the ICRG data in their research (Howell & Chaddick, 1994;Erb, Harvey and Viskanta, 1996;Assane & Grammy, 2003;Harvey, 2004;Hoti, 2005;Busse & Hefeker, 2007;Lehkonen & Heimonen, 2015;Nawaz, 2015;Hakimi & Hamdi, 2017;Asif & Majid, 2018;Aziz, 2018;Filippou, Gozluklu & Taylor, 2018;Kirikkaleli, 2020;etc.). Economic, financial and political risk ratings provided by ICRG are scored between 0-50, 0-50 and 0-100, respectively (for more information see, Howell, 2011).…”

Does policy uncertainty of the blockchain dampen ICO markets?

“…Similarly, Panagiotidis et al (2018) find that Chinese EPU is negatively related with bitcoin returns. Political uncertainty is also priced in the equity option market (Kelly et al , 2016) and currency momentum (Filippou et al , 2018). Prior research documents that policy uncertainty is negatively correlated with stock returns (Ko and Lee, 2015; Arouri et al , 2016; Liu et al , 2017).…”

“…Thirdly, we add evidence to the literature on the effects of policy uncertainty on capital markets. Related capital market effects have been widely documented for the stock market (Ko and Lee, 2015; Liu and Zhang, 2015; Arouri et al , 2016; Liu et al , 2017; Tsai, 2017), the option market (Kelly et al , 2016), the currency exchange (Filippou et al , 2018) and the cryptocurrency market (Demir et al , 2018; Panagiotidis et al , 2018). Kurov and Stan (2018) show that policy uncertainty has different effects in different capital markets.…”

US Equity Tail Risk and Currency Risk Premia

“…Several studies show that different variables can explain the excess return of the carry trade returns; for example, US consumption risk in Lustig and Verdelhan (2007), innovations to FX volatility in Menkhoff, Sarno, Schmeling, and Schrimpf (2012a), US equity downside risk in Lettau, Maggiori, and Weber (2014) and Dobrynskaya (2014), global long-run consumption news in Colacito, Croce, Gavazzoni, and Ready (2018), and global imbalances in Della Corte, Riddiough, and Sarno (2016). Filippou, Gozluklu, and Taylor (2018) show that the winner portfolio in the currency momentum strategy is compensated for the exposure to the global political risk of those currencies. The variables in the aforementioned papers have difficulties explaining the returns of carry and momentum strategies simultaneously.…”