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Is Currency Momentum a Hedge for Global Economic Risk?

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper titled “Is Currency Momentum a Hedge for Global Economic Risk?” by Klaus Grobys, Jari-Pekka Heinonen, and James W. Kolari explores the potential correlation between momentum in currency returns and global economic risk, as measured by currency return dispersion (RD).

The study presents initial tests indicating the presence of a macroeconomic risk component in currency and global equity markets. Further tests reveal that zero-cost currency momentum strategies exhibit larger and highly significant spreads in high RD states compared to low RD states.

Additionally, the findings suggest a linear increase in the relationship between momentum payoffs and global economic risk. It is evident from the evidence that the paper sheds light on the explanation of currency momentum profits through global economic risk proxied by RD.

Abstract Of Paper

We investigate the potential link between momentum in currency returns and global economic risk as measured by currency return dispersion (RD). Initial tests contribute to the exchange rate puzzle by showing that the same macroeconomic risk component in currency markets is present in global equity markets. Subsequent tests indicate that the spread on zero-cost currency momentum strategies is larger and highly significant in high RD states compared to low RD states. Also, the relation between these momentum payoffs and global economic risk appears to increase linearly in risk. Based on this evidence, we conclude that global economic risk as proxied by RD helps to explain currency momentum profits.

Original paper – Download PDF

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Author

Klaus Grobys
University of Vaasa; University of Jyväskyla

Jari-Pekka Heinonen
University of Vaasa – Department of Accounting and Finance

James W. Kolari
Texas A&M University – Department of Finance

Conclusion

In conclusion, the research paper “Is Currency Momentum a Hedge for Global Economic Risk?” by Klaus Grobys, Jari-Pekka Heinonen, and James W. Kolari provides valuable insights into the relationship between currency momentum and global economic risk.

The study’s findings offer compelling evidence that global economic risk, as measured by RD, serves as a determinant of currency momentum profits. The revelation of larger and highly significant spreads in high RD states opposes the low RD states further expands the understanding of this interrelationship.

The linear increase observed in the association between momentum payoffs and global economic risk underscores the role of RD in explaining currency momentum profits.

The paper’s contributions open avenues for additional exploration into the dynamics of currency markets and their interactions with global economic risk, offering significant implications for investors and policymakers.

Related Reading:

Systematic Intervention and Currency Risk Premia

Beta’em Up: What is Market Beta in FX?

FAQ

Q1: What is the main focus of the research paper “Is Currency Momentum a Hedge for Global Economic Risk?” by Klaus Grobys, Jari-Pekka Heinonen, and James W. Kolari?

A1: The main focus of the research paper is to investigate the potential link between momentum in currency returns and global economic risk, as measured by currency return dispersion (RD). The study explores the presence of a macroeconomic risk component in currency and global equity markets and examines the relationship between zero-cost currency momentum strategies and RD.

Q2: What are the key findings of the study regarding the relationship between currency momentum and global economic risk?

A2: The study finds that there is a potential link between currency momentum and global economic risk, as proxied by RD. Initial tests indicate the presence of a macroeconomic risk component in both currency and global equity markets. The spread on zero-cost currency momentum strategies is reported to be larger and highly significant in high RD states compared to low RD states. The relationship between momentum payoffs and global economic risk appears to increase linearly, suggesting that RD helps explain currency momentum profits.

Q3: How does the study contribute to the understanding of currency momentum profits?

A3: The study contributes to the understanding of currency momentum profits by highlighting the role of global economic risk, as proxied by RD, in explaining these profits. The evidence of larger and more significant spreads in high RD states suggests that global economic risk is a determinant of currency momentum profits. The linear increase in the relationship between momentum payoffs and global economic risk further elucidates the dynamics of this interrelationship.

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