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Empirical Economics

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20-10-2020

Market news co-moments and currency returns

Authors: Mohammadreza Tavakoli Baghdadabad, Girijasankar Mallik

Published in: Empirical Economics | Issue 4/2021

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Abstract

We propose three co-moments of the market returns’ cash-flow, and discount-rate shocks and examine empirically an intertemporal capital asset pricing model using the co-moments on currency returns as well as stock returns during Dec. 1983 to Dec. 2017. We find that our proposed model has explanatory power for both currency and stock portfolios. We find several common sources of market risk in currency and stock returns that are reflected in market news. Our findings show that the co-moments are related to currency risk premiums and outperform the well-known liquidity, dollar and HML risk factors.

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Dittmar (2002) supports their findings and finds that a four-moment CAPM can price the cross section of returns much better than the CAPM. Fang and Lai (1997) also provide more supportive evidence about higher power of a four-moment CAPM model for pricing asset returns.

The carry trade strategy borrows in low-interest-rate currencies and invests in high-interest-rate currencies.

See http://www.federalreserve.gov/releases/h15/data.htm.

See online data at http://www.econ.yale.edu/~shiller/data.htm.

These data are available in the Kenneth R. French data library.

As mentioned in Campbell and Vuolteenaho (2004), we set \(\rho = 0.95^{1/12}\) in Table 1. The \(\rho\) can be related to either the average dividend yield or the average consumption–wealth ratio. An annualized \(\rho\) of 0.95 corresponds to an average dividend-price or consumption–wealth ratio of 5.2%, where wealth is measured after subtracting consumption. We pick the value 0.95 because 5% consumption of total wealth per year seems reasonable for a long-term investor.

The detailed results of correlations are available on request.

The results of the correlations are available on request.

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Title: Market news co-moments and currency returns
Authors: Mohammadreza Tavakoli Baghdadabad
Girijasankar Mallik
Publication date: 20-10-2020
Publisher: Springer Berlin Heidelberg
Published in: Empirical Economics / Issue 4/2021
Print ISSN: 0377-7332
Electronic ISSN: 1435-8921
DOI: https://doi.org/10.1007/s00181-020-01951-y

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