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Currency Management: adding value with factor investing

Which factors add value in currency selection?

Experienced asset allocators have a good idea of the factors that investors pay attention to, when investing in currency markets. But do factors such as interest rate differentials, momentum and value have a robust underpinning?

The Savvy Investor research team has identified, below, ten white papers which cover the issues around factor investing for currency markets.

Savvy Investor

Common Risk Factors in Currency Markets (NBER, 2015)
Low interest rate currencies have a low 'slope' and high interest rate currencies have a 'high slope'. The 'slope' accounts for a great deal of the cross-sectional variation in excess returns.

A New Look at Currency Investing - CFA Institute Research Foundation (2012)
This wide-ranging paper examine the rationale for investing in currency, and the drivers of currency returns.

The Magnitude, Causes, and Duration of Currency Carry Unwinds (FAJ, 2017)
This 24-page paper appears in CFA's FAJ. It looks back and analyses the worst periods of currency carry loss in recent years, including timing, causes, duration of carry drawdowns and attribution by currency.

Is There Alpha Left in FX? The Return of Trends - And Your Other Friends (2015)
The authors believe there will be two sources of alpha in FX: First, while big trends have been elusive, they are likely to return as economies start diverging. Second, there are a number of alpha sources independent of big trends.

The Missing Risk Premium in Exchange Rates (2016)
It is well known that the interest rate differential predicts currency returns. However, the authors find that the real exchange rate, not the interest rate differential, is the main predictor of currency returns at longer horizons.

Currency Momentum Strategies (2011)
The authors investigate momentum strategies in foreign exchange markets.

Forward Premium Bias, Carry Trade and the Risks of Volatility and Liquidity (2016)
Examining the relationship between carry, volatility and liquidity risk in FX markets.

The Currency Carry Trade: Is It Still Viable?
This article analyses three distinct time regimes, each generating different outcomes for the carry trade.

Currency valuation and risk premia (2016)
What is the best way of assessing currency valuation levels? This brief article suggests a new way of adjusting real exchange rates for important country-specific fundamentals to obtain more accurate insights into currency valuations.

Economic Momentum and Currency Returns (2017)
The authors document the effects of a trading strategy that goes long currencies in countries with good economic momentum and short currencies in countries with poor economic momentum.

The Carry and Value Pendulum (PIMCO, 2016)
This paper examines carry and value, and argues that, rather than treating them as stand-alone factors, investors should regard them to be related components of an asset’s total expected return.

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