The Quanto Theory of Exchange Rates
- (pp. 810-43)
Abstract
We present a new identity that relates expected exchange rate appreciation to a risk-neutral covariance term, and use it to motivate a currency forecasting variable based on the prices of quanto index contracts. We show via panel regressions that the quanto forecast variable is an economically and statistically significant predictor of currency appreciation and of excess returns on currency trades. Out of sample, the quanto variable outperforms predictions based on uncovered interest parity, on purchasing power parity, and on a random walk as a forecaster of differential (dollar-neutral) currency appreciation.Citation
Kremens, Lukas, and Ian Martin. 2019. "The Quanto Theory of Exchange Rates." American Economic Review, 109 (3): 810-43. DOI: 10.1257/aer.20180019Additional Materials
JEL Classification
- C53 Forecasting Models; Simulation Methods
- E43 Interest Rates: Determination, Term Structure, and Effects
- F31 Foreign Exchange
- F37 International Finance Forecasting and Simulation: Models and Applications
- G12 Asset Pricing; Trading Volume; Bond Interest Rates
- G15 International Financial Markets