Global Currency Hedging with Common Risk Factors
with Wei Opie. Latest version: May 2019.
Journal of Financial Economics forthcoming
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
with Pasquale Della Corte and Lucio Sarno
Review of Financial Studies
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.
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
The Two Faces of Cross-Border Banking Flows
with Dennis Reinhardt
IMF Economic Review
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.
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
Business Cycles and Currency Returns
with Ric Colacito and Lucio Sarno. Latest version: January 2019.
R&R Journal of Financial Economics
2017 "WINNER" Best Paper Award Second Prize (ZZ Vermögensverwaltung and POK Pühringer Privatstiftung in collaboration with WU Vienna University of Economics and Business)
2017 CFA Best Paper Prize, FIRN Annual Conference
Media coverage: CFA Institute, published 30 July 2018
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.
Foreign Exchange Volume
with Antonio Gargano and Lucio Sarno. Latest version: April 2019
R&R Review of Financial Studies
We provide the first comprehensive study of foreign exchange (FX) volume using a novel dataset offering the broadest coverage of volume at high frequency. FX volume is related to volatility, liquidity, information arrival, and return spreads across equity and bond markets. However we find it is the unexpected component of volume that can predict short-term currency returns: when a currency pair's daily volume is unexpectedly low, it exhibits a strong return reversal over the following day. This predictability is economically valuable for currency investors and is consistent with an asymmetric information hypothesis, in which privately informed trading increases with volume.
Work in Progress
Fake Volume in Cryptocurrency Markets
with Vincent Gregoire and Zhuo Zhong
Portfolio Choices among Immigrants
with Martin Ljunge and Alexander Ljungqvist