ASJA BOSNIC

I use the GEPU (global economic policy uncertainty)  of Baker, Bloom and Davis (2016) in a two-factor model, and successfully price the cross-section of 6 currency portfolios sorted on forward discounts.  

The factor-mimicking GEPU has a statistically significant premium of -13.8%  p.a. in a sample of 48 currencies from 1990-2016, and there is a monotonic increase in the beta loadings on the portfolios.  Additionally,  beta-sorted portfolios have monotonically decreasing forward rates and mean excess returns. I.e., when uncertainty is high, returns are low. This is consistent with a risk-based explanation of FX returns.

Presented at the Nordic Finance Network PhD Seminar 2022

APPENDIX

We propose a two-factor model that uses investor uncertainty proxied by News Implied Volatility innovations (NVIX) and the dollar factor to explain the profitability of the carry trade strategy. Our model explains 86% of the variation in currency returns. The NVIX innovations factor commands a negative risk premium of 12.9% per annum. In addition, we use NVIX’s forecasting ability in carry trade returns to hedge the downside risk and improve the profitability of the carry trade strategy.

Winner of the 2020 NFI Master Thesis Award