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Cross-Sectional Return Dispersion and Currency Momentum

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Cross-Sectional Return Dispersion and Currency Momentum” by Jonas N. Eriksen delves into an assessment of the link between cross-sectional return dispersion in foreign exchange (FX) markets and currency momentum.

The study offers profound insights into the pricing of cross-sectional dispersion in the cross-section of currency momentum returns, illustrating that an unanticipated upsurge in cross-sectional dispersion correlates with positive (negative) excess returns to winner (loser) currencies.

This observed mechanism may be associated with the prevailing monetary policy conditions. Impressively, the empirical findings remain robust even with the inclusion of customary currency risk factors, liquidity and market volatility variables, and transaction costs.

Notably, the research establishes that the explanatory capacity of cross-sectional dispersion transcends beyond specific currency portfolios to encompass broader cross-sections and individual currencies, contributing to a comprehensive understanding of the intricate dynamics governing currency momentum and return dispersion in FX markets.

Abstract Of Paper

I assess the relation between cross-sectional return dispersion in foreign exchange (FX) markets and currency momentum. I find that cross-sectional dispersion is priced in the cross-section of currency momentum returns and that an unexpected increase in cross-sectional dispersion is associated with positive (negative) excess returns to winner (loser) currencies. This mechanism can be related to monetary policy conditions. The empirical findings are robust to the inclusion of traditional currency risk factors, liquidity and market volatility variables, and transaction costs. Finally, the explanatory ability of cross-sectional dispersion extends to broader cross-sections of currency portfolios and to individual currencies.

Original paper – Download PDF

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Author

Jonas N. Eriksen
Aarhus University, DFI

Conclusion

In conclusion, the research paper “Cross-Sectional Return Dispersion and Currency Momentum” by Jonas N. Eriksen presents compelling insights on the intricate link between cross-sectional return dispersion in foreign exchange (FX) markets and currency momentum.

The study unveils the pricing of cross-sectional dispersion in the cross-section of currency momentum returns, elucidating how an unforeseen escalation in cross-sectional dispersion reflects in positive (negative) excess returns to winner (loser) currencies.

This mechanism is intricately linked to the prevalent monetary policy conditions. Notably, the empirical robustness of these findings persists even with the incorporation of conventional currency risk factors, liquidity and market volatility variables, and transaction costs.

Moreover, the research underscores that the explicative prowess of cross-sectional dispersion extends across broader cross-sections of currency portfolios and individual currencies, offering a comprehensive understanding of the complexities underlying currency momentum and return dispersion in FX markets.

Related Reading:

Currency Momentum Strategies

A New Look at Currency Investing

FAQ

Q1: What is the main focus of the research paper “Cross-Sectional Return Dispersion and Currency Momentum” by Jonas N. Eriksen?

A1: The main focus of the research paper is to assess the relationship between cross-sectional return dispersion in foreign exchange (FX) markets and currency momentum. The study investigates how the pricing of cross-sectional dispersion in the cross-section of currency momentum returns influences the excess returns of winner and loser currencies.

Q2: What does the research reveal about the relationship between cross-sectional dispersion and currency momentum returns?

A2: The research reveals that cross-sectional dispersion is priced in the cross-section of currency momentum returns. Specifically, an unexpected increase in cross-sectional dispersion is associated with positive excess returns to winner currencies and negative excess returns to loser currencies. The study explores the potential connection between this mechanism and prevailing monetary policy conditions.

Q3: How does the empirical robustness of the findings hold up against the inclusion of various factors and variables?

A3: The empirical findings remain robust even with the inclusion of traditional currency risk factors, liquidity and market volatility variables, and transaction costs. This indicates that the observed relationship between cross-sectional return dispersion and currency momentum is not easily explained away by these commonly considered factors.

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