A1061
Title: Common factors in currency characteristics
Authors: Dennis Umlandt - University of Innsbruck (Austria) [presenting]
Moritz Dauber - University of Innsbruck (Austria)
Abstract: The factor structure of currency characteristics are studied by employing a three-dimensional tensor factor model that simultaneously captures the variation in characteristics of the G10 currencies over time. It is shown that factor-mimicking portfolios derived from these common factors in currency characteristics are able to price individual currency returns better than standard factor models derived from univariate sorts on the same characteristics. The variation in currency characteristics can be well captured by a parsimonious two-factor model, where the first factor closely resembles the carry trade and the second factor acts as a hedge against carry crash risk, which is composed of signals from FX momentum, FX value, and the term spread. A potential third factor, which dynamically weights several characteristics, incrementally improves the fit of the total variation, but has a high Sharpe ratio.
