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Currency Value

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Currency Value” by Lukas Menkhoff, Lucio Sarno, Maik Schmeling, and Andreas Schrimpf delves into an assessment of currency value strategies predicated on real exchange rates within a cross-sectional portfolio framework.

Through a rigorous analysis, the study sheds light on the predictive properties of real exchange rates vis-à-vis currency excess returns, unraveling a paradoxical conundrum wherein a higher valuation level augurs a relative appreciation of the foreign currency in the future.

Interestingly, the research adjusts real exchange rates by accounting for two pivotal country-specific fundamentals: productivity and the quality of export goods. This formulation engenders a measure of currency value that presciently predicts currency excess returns, aligning cohesively with the prospect of spot exchange rate reverting towards fundamental value.

The study tenderly dissects the intricate nuances of currency value strategies, uncovering the intricacies inherent in real exchange rate predictability, lending profound insights into the dynamics of currency valuation grounded in macro fundamentals.

Abstract Of Paper

We assess the properties of currency value strategies based on real exchange rates in a cross-sectional portfolio setting. We find that real exchange rates predict currency excess returns, but in a way that is inconsistent with the notion of currency value because a high valuation level forecasts a relative appreciation of the foreign currency going forward. However, adjusting real exchange rates for two key country-specific fundamentals — productivity and the quality of export goods — generates a measure of currency value which still predicts currency excess returns and is consistent with the spot exchange rate reverting toward fundamental value.

Original paper – Download PDF

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Author

Lukas Menkhoff
German Institute for Economic Research (DIW Berlin); Humboldt University of Berlin – Faculty of Economics

Lucio Sarno
University of Cambridge – Judge Business School; Centre for Economic Policy Research (CEPR)

Maik Schmeling
Goethe University Frankfurt – Department of Finance; Centre for Economic Policy Research (CEPR)

Andreas Schrimpf
Bank for International Settlements (BIS) – Monetary and Economic Department; Centre for Economic Policy Research (CEPR); University of Tuebingen

Conclusion

In conclusion, the research paper “Currency Value” authored by Lukas Menkhoff, Lucio Sarno, Maik Schmeling, and Andreas Schrimpf unfurls a comprehensive panorama of currency value strategies rooted in real exchange rates within a cross-sectional portfolio context.

The study, astutely navigating the juncture of real exchange rates and currency excess returns, discerns an intriguing paradox where a lofty valuation level portends a forthcoming relative appreciation of the foreign currency.

Profoundly, the researchers recalibrate real exchange rates by factoring in country-specific fundamentals: productivity and the caliber of export goods. Notably, this recalibration begets a currency value measure that adeptly prognosticates currency excess returns, harmonizing seamlessly with the conception of spot exchange rates gravitating towards fundamental value.

The study, through its meticulous scrutiny, advances a nuanced understanding of currency value, contextualized against macro fundamentals and real exchange rate predictability, paving the way for a discerning discourse on the intricacies enshrined within the contours of currency valuation.

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FAQ

Q1: What is the focus of the research paper “Currency Value” by Lukas Menkhoff, Lucio Sarno, Maik Schmeling, and Andreas Schrimpf?

A1: The research paper focuses on assessing currency value strategies based on real exchange rates within a cross-sectional portfolio framework. It explores the predictive properties of real exchange rates in relation to currency excess returns.

Q2: How does the research adjust real exchange rates to create a measure of currency value, and what is the predictive power of this measure?

A2: The research adjusts real exchange rates by incorporating two country-specific fundamentals: productivity and the quality of export goods. This adjustment results in a measure of currency value that predicts currency excess returns. The measure is consistent with the idea of spot exchange rates reverting toward fundamental value.

Q3: Who are the authors of the paper, and what are their affiliations?

A3: The authors of the paper are Lukas Menkhoff, Lucio Sarno, Maik Schmeling, and Andreas Schrimpf. Lukas Menkhoff is affiliated with the German Institute for Economic Research (DIW Berlin) and Humboldt University of Berlin. Lucio Sarno is affiliated with the University of Cambridge – Judge Business School. Maik Schmeling is affiliated with Goethe University Frankfurt. Andreas Schrimpf is affiliated with the Bank for International Settlements (BIS), University of Tuebingen, and Centre for Economic Policy Research (CEPR).

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