DP10016 Common Macro Factors and Currency Premia

Author(s): Ilias Filippou, Mark P Taylor
Publication Date: June 2014
Keyword(s): Carry Trade, Factor Analysis, Foreign Exchange, Forward Premium Puzzle, Momentum
JEL(s): F31, G11, G15
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10016

We study the role of domestic and global factors on payoffs of portfolios built to mimic carry, dollar carry and momentum strategies. We construct domestic and global factors from a large dataset of macroeconomic and financial variables and find that global equity market factors render strong predictive power for carry trade returns, while U.S. inflation and consumption variables drive dollar carry trade payoffs and momentum returns are driven by global commodity and U.S. inflation factors. We find evidence of predictability in the exchange rate component of each strategy and demonstrate strong economic value to a risk-averse investor with mean-variance preferences.