Working Paper: CEPR ID: DP18012
Authors: Federico Nucera; Lucio Sarno; Gabriele Zinna
Abstract: We study a large currency cross section using asset pricing methods which account for omitted-variable and measurement-error biases. First, we show that the pricing kernel includes at least three latent factors which resemble (but are not identical to) a strong U.S. “Dollar” factor, and two weak, high Sharpe ratio “Carry” and “Momentum” slope factors. Evidence for an additional “Value” factor is weaker. Second, using this pricing kernel, we find that only a small fraction of the over 100 nontradable candidate factors considered have a statistically significant risk premium – mostly relating to volatility, uncertainty and liquidity conditions, rather than macro variables.
Keywords: currency risk premia; asset pricing; omitted factors; measurement error; weak factors
JEL Codes: F31; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| latent pricing factors (F16) | risk premia of nontradable factors (F16) |
| strong dollar factor (F31) | risk premia of nontradable factors (F16) |
| carry factor (F16) | risk premia of nontradable factors (F16) |
| momentum factor (C69) | risk premia of nontradable factors (F16) |
| measurement error and omitted variable bias (C20) | risk premia of nontradable factors (F16) |
| latent pricing factors (F16) | pricing performance of SDF (D49) |
| nontradable candidate factors (P23) | risk premia (G22) |
| macroeconomic variables (E19) | currency portfolio returns (G15) |