Country Fundamentals and Currency Excess Returns

• Main Authors: Daehwan Kim, Chi-Young Song
• Format: Article
• Language: English
• Published: Korea Institute for International Economic Policy 2014-06-01
• Series: East Asian Economic Review
• Subjects: Currency Excess Returns; Country Fundamentals; Factor Model; Fundamental Factors; Investment-style Factors
• Online Access: http://dx.doi.org/10.11644/KIEP.JEAI.2014.18.2.277

We examine whether country fundamentals help explain the cross-section of currency excess returns. For this purpose, we consider fundamental variables such as default risk, foreign exchange rate regime, capital control as well as interest rate in the multi-factor model framework. Our empirical results show that fundamental factors explain a large part of the cross-section of currency excess returns. The zero-intercept restriction of the factor model is not rejected for most currencies. They also reveal that our factor model with country fundamentals performs better than a factor model with usual investment-style factors. Our main empirical results are based on 2001-2010 balanced panel data of 19 major currencies. This paper may fill the gap between country fundamentals and practitioners' strategies on currency investment.