The Share of Systematic Variation in Bilateral Exchange Rates

Verdelhan, Adrien

doi:10.2139/ssrn.1930516

Cited by 41 publications

(78 citation statements)

References 62 publications

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“…One might also worry that SC might be picking up known factors present in currency returns. In Table IA.X, we show that our results are similar when we include the dollar factor from Verdelhan (), the carry factor from Verdelhan (), or the excess return of high interest rate currencies minus low interest rate currencies from Lustig, Roussanov, and Verdelhan () . In a similar vein, in Table IA.XI, we find that our results are virtually unchanged when we augment the five‐factor model with momentum or the liquidity factor of Pastor and Stambaugh ().…”

Section: Measuring the Globalization Risk Premiummentioning

confidence: 65%

The Globalization Risk Premium

Barrot¹,

Loualiche²,

Sauvagnat

2019

The Journal of Finance

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In this paper, we investigate how globalization is reflected in asset prices. We use shipping costs to measure firms' exposure to globalization. Firms in low shipping cost industries carry a 7% risk premium, suggesting that their cash flows covary negatively with investors' marginal utility. We find that the premium emanates from the risk of displacement of least efficient firms triggered by import competition. These findings suggest that foreign productivity shocks are associated with times when consumption is dear for investors. We discuss conditions under which a standard model of trade with asset prices can rationalize this puzzle.RECENT DECADES HAVE BEEN CHARACTERIZED by a high degree of trade integration. This era of globalization 1 is generally seen in a positive light, as it has been associated with more product variety at lower prices, cheaper intermediate goods, and greater access for U.S. firms to foreign markets. 2 Yet globalization also makes domestic economies more sensitive to foreign shocks. A salient * Jean-Noël Barrot is with HEC Paris and CEPR. Erik Loualiche is with the University of Minnesota, Carlson School of Management. Julien Sauvagnat is with Bocconi University and CEPR. For helpful comments, the authors thank Stefan Nagel (the Editor); Nick Bloom; Maria Cecilia Bustamante (discussant); Bernard Dumas (discussant); Nicola Gennaioli; Matthieu Gomez; Pierre-Olivier Gourinchas; Tarek Hassan (discussant); Christian Julliard; Matteo Maggiori (discussant); Jonathan Parker; Carolin Pflueger; Thomas Philippon; Nick Roussanov (discussant); Chris Telmer (discussant); Adrien Verdelhan; Michael Weber (discussant); anonymous referees; and seminar participants at MIT Sloan, SED annual meetings 1 σ J −1 . 24 We show formally in Internet Appendix Section I.A that the consumption index is C J = ( J c J (ϕ) σ J −1 σ J dϕ) σ J σ J −1 and the price index is P J = ( J p J (ϕ) 1−σ J dϕ) 1 1−σ J .We show that average profits of firms' domestic operations are π D,J (φ D,J ) and average profits for exporting operations are π X,J (φ X,J ). We define the fraction of firms that decide to export as ζ J = Pr{ϕ > ϕ X,J }. Finally, we express the profits of domestic firms from all their operations asEquilibrium: The aggregate budget constraint can be expressed in terms of the final composite consumption good, C, the aggregate price index, P, and the revenues of firms flowing back to households, , such that in each country we have PC ≤ L + .Under financial autarky, as is the case in Ghironi and Melitz (2005), households only receive the proceeds of domestic firms' operations, such that AUT = J J . Under perfect risk-sharing, households receive a share of world industry profits relative to their capital endowments, RS = J M J M J +M J

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Section: Measuring the Globalization Risk Premiummentioning

confidence: 65%

The Globalization Risk Premium

Barrot¹,

Loualiche²,

Sauvagnat

2019

The Journal of Finance

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“…To answer this question, we use the extended international asset‐pricing model proposed by Brusa et al ().

r_{i, t} = α_{i} + β_{i} r_{W, t}^{Local} + γ_{i} {Carry}_{t} + φ_{i} {Dollar}_{t} + ε_{i, t} .

where

r_{W, t}^{Local}

is the excess return on the MSCI world market index in local currencies, Carry t and Dollar t are the carry and dollar factors of Lustig, Roussanov, and Verdelhan () and Verdelhan () (which parsimoniously describe the cross section of exchange rates). Daily carry and dollar factors are generously provided by Professor Adrien Verdelhan.…”

Section: Discussionmentioning

confidence: 99%

US macroannouncements and international asset pricing

2017

Int. J Fin Econ

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The world capital asset-pricing model is the benchmark model in international finance. However, recent research finds that the premium on the world market factor is insignificant. In this paper, we investigate if the world market risk premium is particularly significant on US macroeconomic announcement days. Empirically, we apply the methodology to daily country exchange-traded funds. Our findings suggest that although the world market risk premium is insignificant on nonannouncement days, it is strongly significant on US macroeconomic announcement days. In addition, we find that US monetary policy announcements are the most important macroeconomic announcements to drive the world market risk premium. Our findings are consistent with the notion of monetary policy uncertainty and the empirical literature that connects policy uncertainty with systematic risk.

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“…To assess the additional explanatory power of Global Tail for currency returns, we consider the following control risk factors: the carry trade risk factor (CARRY) in Lustig et al (2011), the innovations in global FX volatility (∆FXvol) in Menkhoff et al (2012a), the innovations in the index of global ex ante tail risk concerns (∆GRIX) in Gao et al (2018), the dollar carry in Lustig et al (2014), and the global Dollar in Verdelhan (2018).…”

Section: Cross-sectional Asset Pricing With Control Factorsmentioning

confidence: 99%

“…Lustig, Roussanov, and Verdelhan (2014) links the return of the dollar carry strategy to US-specific business cycle variations. Verdelhan (2018) shows that the global component of the dollar factor, which is calculated as the average appreciation rates of a set of currencies with respect to the US dollar, explains a large portion of the variation in bilateral exchange rates. A few papers specifically link developments in stock markets with currency returns.…”

Section: Introductionmentioning

confidence: 99%

“…This table reports the results for the asset pricing tests on the cross-section of currency carry and momentum portfolios after including other control factors in addition to the global US tail factor (Global Tail). The control factors include the carry trade risk factor (CARRY) in Lustig et al (2011); the change in foreign exchange volatility (∆FXvol) in Menkhoff et al (2012a); the index of global ex-ante tail risk concerns (∆GRIX) in Gao et al (2018); the dollar carry in Lustig et al (2014); and the global Dollar in Verdelhan (2018). We obtain the GRIX data from the website of Zhaogang Song: https://sites.google.com/ a/cornell.edu/zgs/.…”

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US Equity Tail Risk and Currency Risk Premia

2019

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We find that a US equity tail risk factor constructed from out-of-the-money S&P 500 put option prices explains the cross-sectional variation of currency excess returns. Currencies highly exposed to this factor offer a low currency risk premium because they appreciate when US tail risk increases. In a reduced-form model, we show that country-specific tail risk factors are priced in the cross section of currency returns only if they contain a global risk component. Motivated by the intuition from the model and by our empirical results, we construct a novel proxy for a global tail risk factor by buying currencies with high US equity tail beta and shorting currencies with low US tail beta. This factor, along with the dollar risk factor, explains a large portion of the cross-sectional variation in the currency carry and momentum portfolios and outperforms other models widely used in the literature.

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The Share of Systematic Variation in Bilateral Exchange Rates

Cited by 41 publications

References 62 publications

The Globalization Risk Premium

The Globalization Risk Premium

US macroannouncements and international asset pricing

US Equity Tail Risk and Currency Risk Premia

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