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The quanto theory of exchange rates

Kremens, Lukas and Martin, Ian (2019) The quanto theory of exchange rates. American Economic Review, 109 (3). pp. 810-843. ISSN 0002-8282

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Identification Number: 10.1257/aer.20180019

Abstract

We present a new identity that relates expected exchange rate appreciation to a risk-neutral covariance term, and use it to motivate a currency forecasting variable based on the prices of quanto index contracts. We show via panel regressions that the quanto forecast variable is an economically and statistically significant predictor of currency appreciation and of excess returns on currency trades. Out of sample, the quanto variable outperforms predictions based on uncovered interest parity, on purchasing power parity, and on a random walk as a forecaster of differential (dollar-neutral) currency appreciation.

Item Type: Article
Additional Information: © 2018 American Economic Association
Divisions: Finance
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
JEL classification: F - International Economics > F3 - International Finance > F31 - Foreign Exchange
F - International Economics > F3 - International Finance > F37 - International Finance Forecasting and Simulation
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F47 - Forecasting and Simulation
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets
Sets: Departments > Finance
Date Deposited: 13 Aug 2018 15:27
Last Modified: 20 Jan 2020 01:30
Projects: 639744
Funders: European Research Council
URI: http://eprints.lse.ac.uk/id/eprint/89839

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