Essays on Asset Pricing in Currency Markets

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2021-12

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Abstract

The first essay, “The Cross-Section of Idiosyncratic Volatility and Expected Returns in Currency Markets” studies the effect of idiosyncratic volatility (IV OL) in currency markets. In equity markets, Ang et al. (2006) and Ang et al. (2009) show that stocks with higher IVOL have lower returns. This negative relation between IV OL and returns is called the “idiosyncratic volatility puzzle.” We study whether the same IV OL puzzle exists in currency markets. We measure IV OL based on the model proposed by Verdelhan (2018). We use daily data for 33 major currencies ranged from July 2006 to March 2021. We find that the IVOL puzzle also exists in currency markets, especially for developing markets currencies. We also analyze the sources of IVOL from the perspective of global government governance, central bank autonomy, currency regime and financial crisis, and national culture. The currency regime and currency crisis are the key dominant sources of IVOL. The second essay, “Beta and Semibetas in Currency Markets,” decomposes the CAPM-beta in currency markets, following Bollerslev et al. (2019), in Semi- βs. We compute four Semi-βs: βN (computed from the covariance when the market and the currency have both negative returns), βP (computed from the covariance when the market and the currency have both positive returns), βM− (computed from the covariance when the market has a negative return and the currency has a positive return), and βM+ (computed from the covariance when the market has a positive return and the currency has a negative return). We find strong support for the pricing of β. The significance and positive pricing of β is robust to different specifications, sample composition, and level of aggregation. With respect to the semi-βs, only βP is priced, with a positive sign. This holds for monthly and bi-monthly levels of aggregation. With respect to the upside and downside βs, we find support for the pricing of the downside βs, when controls are included. There are substantialvi dynamic connections among the βs and semi-βs, with the currency semi-βs showing higher linkages than the currency βs.

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Asset Pricing, Idiosyncratic Volatility, Semibetas, Transmission, Currency Markets

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