Discussion Paper Details

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Title: The Quanto Theory of Exchange Rates

Author(s): Lukas Kremens and Ian Martin

Publication Date: April 2017

Keyword(s): carry trade, currency, Exchange rate, exchange rate forecast, Forecasting, predictability and quanto contracts

Programme Area(s): Financial Economics and International Macroeconomics and Finance

Abstract: We present a new, theoretically motivated, forecasting variable for exchange rates that is based on the prices of quanto index contracts, and show via panel regressions that the quanto forecast variable is a statistically and economically significant predictor of currency appreciation. We also test the quanto variable's ability to forecast differential currency appreciation out of sample, and find that it outperforms predictions based on uncovered interest parity, on purchasing power parity, and on a random walk.

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Bibliographic Reference

Kremens, L and Martin, I. 2017. 'The Quanto Theory of Exchange Rates'. London, Centre for Economic Policy Research.