International correlation risk

Mueller, Philippe, Stathopoulos, Andreas and Vedolin, Andrea (2014) International correlation risk. SRC Discussion Paper, No 26. Systemic Risk Centre, The London School of Economics and Political Science, London, UK.

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Abstract

We document that cross-sectional FX correlation disparity is countercyclical, as exchange rate pairs with high average correlation become more correlated in bad times whereas pairs with low average correlation become less correlated. We show that currencies that perform badly (well) during periods of high cross-sectional disparity in conditional FX correlation yield high (low) average excess returns, suggesting that correlation risk is priced in currency markets. Furthermore, we find a negative cross-sectional relationship between average FX correlations and average FX correlation risk premia. Finally, we propose a no-arbitrage model that can match salient properties of FX correlations and correlation risk premia.

Item Type:	Monograph (Discussion Paper)
Official URL:	http://www.systemicrisk.ac.uk/
Additional Information:	© 2014 Systemic Risk Centre, The London School of Economics and Political Science
Library of Congress subject classification:	H Social Sciences > HG Finance
Journal of Economic Literature Classification System:	R - Urban, Rural, and Regional Economics > R2 - Household Analysis > R21 - Housing Demand
Sets:	Research centres and groups > Systemic Risk Centre
Identification Number:	No 26
Funders:	Economic and Social Research Council
Projects:	ES/K002309/1
Date Deposited:	16 Feb 2015 14:50
URL:	http://eprints.lse.ac.uk/60955/

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