Filippou, Ilias (2014) Essays on empirical asset pricing in the foreign exchange market. PhD thesis, University of Warwick.

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Abstract

This thesis focuses on the dynamics of currency premia. Specifically, we study the time-series and cross-sectional variation of currency carry trade and momentum strategies.

In the first chapter, we study the role of domestic and global factors on payoffs of portfolios built to mimic carry, dollar carry and momentum strategies. We construct domestic and global factors from a large dataset of macroeconomic and financial variables and find that global equity market factors render strong predictive power for carry trade returns, while U.S. inflation and consumption variables drive dollar carry trade payoffs and momentum returns are driven by U.S. inflation factors. In addition, global factors can capture the countercyclical nature of currency premia. We also find evidence of predictability in the exchange rate component of each strategy and demonstrate strong economic value to a risk-averse investor with mean-variance preferences.

In the second chapter, we propose a measure of global political risk relative to U.S. that captures unexpected political conditions. Global political risk is priced in the cross-section of currency momentum and it 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, i.e., the past winners, and exploit the lower returns of loser portfolios.

In the third chapter, we identify a unique dimension of currency carry trades that it is related to the intensity of technology transition across countries. Particularly, we show that technology diffusion is a fundamental determinant of currency premia and it is priced in the cross-section of currency excess returns. We define a novel risk factor that captures the cross-country diffusion of technology. Investment currencies load positively on the global technology diffusion factor while funding currencies load negatively. Intuitively, we show that carry traders require a risk premium for financing risky innovation in countries with low technology diffusion.

Item Type:	Thesis (PhD)
Subjects:	H Social Sciences > HG Finance
Library of Congress Subject Headings (LCSH):	Foreign exchange, Carry trades (Foreign exchange)
Official Date:	2014
Dates:	Date Event 2014 Submitted
Institution:	University of Warwick
Theses Department:	Warwick Business School
Thesis Type:	PhD
Publication Status:	Unpublished
Supervisor(s)/Advisor:	Taylor, Mark P., 1958- ; Bartram, Söhnke M.
Sponsors:	Economic and Social Research Council (Great Britain)
Extent:	xii, 214 leaves : charts
Language:	eng

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