Factor investing and currency portfolio management

Li, D., Zhang, Z. and Cerrato, M. (2023) Factor investing and currency portfolio management. International Review of Financial Analysis, 87, 102626. (doi: 10.1016/j.irfa.2023.102626)

Abstract

Currency-specific pricing factors are pervasive in international asset pricing. However, portfolio and risk management based on forex factors, instead of individual currencies, are rarely discussed. This paper tries to fill this gap by modelling dynamic correlations and non-normality among forex factors. By considering the four most popular forex factors: the dollar risk factor, the carry trade factor, the currency momentum factor, and the currency value factor, we find that a dynamic conditional correlation copula (DCC-copula) model with skewed-t kernel fits the joint distribution well. We show that, for risk-averse investors who focus on factor investing or employ the forex factors to resize the specific risk exposure, ignoring the tail dependence structure of forex factors brings significant costs.

• Item Type: Articles
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Cerrato, Professor Mario and Zhang, Zhekai and LI, Danyang
• Authors: Li, D., Zhang, Z., and Cerrato, M.
• College/School: College of Social Sciences > Adam Smith Business School > Accounting and Finance
• Journal Name: International Review of Financial Analysis
• Publisher: Elsevier
• ISSN: 1057-5219
• ISSN (Online): 1873-8079
• Published Online: 22 March 2023
• Copyright Holders: Copyright © 2023 Elsevier Inc.
• First Published: First published in International Review of Financial Analysis 87:102626
• Publisher Policy: Reproduced in accordance with the publisher copyright policy