Working Papers

Cross-Border M&A Flows, Economic Growth, and Foreign Exchange Rates

with Jodie Zhang (QUT). Latest version: June 2023.
Revise and Resubmit Review of Financial Studies
Presentations: Santiago Finance Workshop (accepted), 2023 WFA, 2022 SFS Cavalcade Asia-Pacific Conference, BIS-Banca d'Italia-ECB 12th Workshop on Exchange Rates, 2022 FMA Asia Pacific Conference, 11th FIRN Annual Conference, 2022 Vienna Symposium on Foreign Exchange Markets, 2022 LBS Summer Finance Symposium, 2022 ASU Sonoran Winter Finance Conference, 2021 CICF, 2021 MFA, HEC Montreal, University of Technology Sydney, Queensland University of Technology.

Abstract. We extract information about future economic conditions from firms' cross-border merger and acquisition announcements, and show it predicts changes in relative economic growth rates and foreign exchange rate returns. We find the predictability is driven by the acquisition decisions of domestic firms, which signal turning points in local economic growth. The findings are motivated via a simple model of exchange rate determination with heterogeneous expectations and support the theorized relationship between foreign exchange rates and macroeconomic fundamentals. The results provide new tools for policy makers seeking to predict economic activity and offer global investors a novel source of portfolio diversification.

On the Use of Currency Forwards: Evidence from International Equity Mutual Funds

with Wei Opie (Deakin). Latest version: May 2023.
Winner of the 2023 Hillsdale Investment Management - CFA Society Toronto Research Award
Winner of the 2023 FIRN Asset Management Meeting Best Paper Award.
Presentations: 10th Annual Melbourne Asset Pricing Meeting, 2023 FIRN Asset Management Meeting

Abstract. We undertake the first comprehensive investigation into the use of currency forwards at international equity mutual funds. Using a unique hand-collected dataset spanning 15-years and over 1,200 US mutual funds, we identify three distinct approaches to using currency forwards that span liquidity, hedging, and speculation motives. We find that foreign exchange momentum, carry, and volatility are all important in determining currency forward positions, and that funds with better currency-picking capabilities are also superior stock pickers. Furthermore, we show that using currency forwards for hedging could have generated substantially stronger investment performance among the group of non-user funds.

Publications

Non-Standard Errors

Menkveld et al. (2023). First crowd-sourced empirical paper in Economics/Finance (300+ co-authors)
Journal of Finance forthcoming

Abstract. In statistics, samples are drawn from a population in a data-generating process (DGP). Standard errors measure the uncertainty in estimates of population parameters. In science, evidence is generated to test hypotheses in an evidence-generating process (EGP). We claim that EGP variation across researchers adds uncertainty: Non-standard errors (NSEs). We study NSEs by letting 164 teams test the same hypotheses on the same data. NSEs turn out to be sizable, but smaller for better reproducible or higher rated research. Adding peer-review stages reduces NSEs. We further find that this type of uncertainty is underestimated by participants.

Foreign Exchange Volume

Cespa, Giovanni, Antonio Gargano, Steven J. Riddiough, and Lucio Sarno, 2022, "Foreign Exchange Volume," Review of Financial Studies 35, pp. 2386-2427.
Media coverage: Quant News (1 and 2), published March 16 2018 and August 24 2018
Media coverage: VoxEU.org, published 17 June 2021

Abstract. We investigate the information contained in foreign exchange (FX) volume using a novel dataset from the over-the-counter market. We find that volume helps predict next day currency returns and is economically valuable for currency investors. Predictability implies a stronger currency return reversal for currency pairs with abnormally low volume today, and is driven by the component of FX volume unrelated to volatility, illiquidity, and order flow. We rationalize these findings via a simple model of exchange rate determination, in which volume helps reveal the degree of asymmetric information in currency markets. Testing this prediction shows that asymmetric information is uniform across currency pairs but varies across instruments.

Business Cycles and Currency Returns

Colacito, Riccardo, Steven J. Riddiough, and Lucio Sarno, 2020, "Business Cycles and Currency Returns," Journal of Financial Economics 137, pp. 659—678.
2017 "WINNER" Best Paper Award Second Prize (Vienna Symposium in FX Markets)
2017 CFA Best Paper Prize, FIRN Annual Conference  
Media coverage: CFA Institute, published 30 July 2018
Media coverage: VoxEU.org, published 10 October 2019

Abstract. We find a strong link between currency 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 strategies, and cannot be understood using traditional risk factors. We also show that a business cycle factor implied by our results is priced in a broad currency cross section. Finally, we propose a mechanism that generates these facts using an international macro-finance model with long-run risk.

Global Currency Hedging with Common Risk Factors

Opie, Wei, and Steven J. Riddiough, 2020, "Global Currency Hedging with Common Risk Factors," Journal of Financial Economics 136, pp. 780—805.

Abstract. We develop a novel method to dynamically hedge foreign exchange exposure in international equity and bond portfolios. The method exploits the time-series predictability of currency returns, which we show emerges from exploiting a forecastable component in global factor returns. The hedging strategy outperforms leading alternative approaches to currency hedging across a large set of out-of-sample performance metrics. Moreover, we find that exploiting currency return predictability via an independent currency portfolio delivers a high risk-adjusted return and provides superior diversification gains to global equity and bond investors relative to currency carry, value, and momentum investment strategies.

Currency Premia and Global Imbalances

Della Corte, Pasquale, Steven J. Riddiough and Lucio Sarno (2016). "Currency Premia and Global Imbalances," Review of Financial Studies 29(8), 2161-2193.
Winner of the Kepos Capital Award for the Best Paper on Investments at the WFA 2013
Winner of an Inquire Europe Research Grant (EUR 10,000)          
Media coverage: VoxEU.org, published 29 February 2016

Abstract. We show that a global imbalance risk factor that captures the spread in countries’ external imbalances and their propensity to issue external liabilities in foreign currency explains the cross-sectional variation in currency excess returns. The economic intuition is simple: net debtor countries offer a currency risk premium to compensate investors willing to finance negative external imbalances because their currencies depreciate in bad times. This mechanism is consistent with exchange rate theory based on capital flows in imperfect financial markets. We also find that the global imbalance factor is priced in cross sections of other major asset markets.

The Two Faces of Cross-Border Banking Flows

Reinhardt, Dennis, and Steven J. Riddiough (2015). "The Two Faces of Cross-Border Banking Flows," IMF Economic Review 63(4), 751-791.              
Bank of England Working Paper No. 498   
Media coverage: VoxEU.org, published 7 May 2014

Abstract. We examine the determinants of cross-border interbank and intra-group funding across crisis and non-crisis periods. Using a previously unexplored data set spanning 25 banking systems, we find aggregate intra-group funding is unrelated to fluctuations in either global or local macroeconomic fluctuations, while flightier interbank funding responds pro-cyclically to both worldwide and domestic economic trends. This feature of the data means intra-group funding remains comparatively stable when global conditions deteriorate -- even during the global financial crisis. During `normal' times we find intra-group funding responds counter-cyclically to global interest rate changes, with parent banks using affiliates to o set tighter global funding conditions. More generally, we find intra-group funding has a closer relationship with domestic banking system profitability and solvency, being used to support banks in weaker banking systems during the global financial crisis.                                              

Work in Progress

Immigrants, Neighborhoods, and Financial Behaviour

with Martin Ljunge (IFN) and Alexander Ljungqvist (SSE)

Gender Norms and Financial Decision Making

with Martin Ljunge (IFN) and Alexander Ljungqvist (SSE)

Customer-Dealer Relationships in the Foreign Exchange Market

with Pasquale Della Corte (Imperial)

Empirical Evidence on Exchange Rate Movements

with Pasquale Della Corte (Imperial)