The authors examine whether macroeconomic fundamentals can consistently predict currency risk premia using a multi currency portfolio approach rather than traditional bilateral exchange rate models. They argue cross sectional differences, not time series changes, drive predictability, with combined macro signals producing Sharpe ratios above 1.0.
Currency Risk Premia and Macro Fundamentals
Lukas Menkhoff, Lucio Sarno
Research
58 Pages
Key Takeaways
Cross Sectional Edge: Cross sectional macro differences explain predictability, while combined macro signals generated unlevered excess returns above 6% and annual Sharpe ratios greater than 1.0.
Macro Signals Matter: Portfolios sorted by real money growth produced a 5.96% annual return spread, while combined real GDP and money growth reached 6.22%.
Business Cycle Exposure: Conditional asset pricing models explained more than 90% of cross sectional return variation, linking currency premia to changing business cycle risks.
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