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Currency Carry, Momentum, and Global Interest Rate Volatility

Published online by Cambridge University Press:  27 December 2023

Ming Zeng Open the ORCID record for Ming Zeng [Opens in a new window]
Ming Zeng*
Affiliation:
University of Gothenburg Department of Economics and the Centre for Finance
*
ming.zeng@cff.gu.se
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Abstract

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Returns to currency carry and momentum compensate for the risk of global interest rate volatility (IRV), with risk exposures explaining 92% of the cross-sectional return variations. This unified explanation stems from its impact on foreign exchange intermediaries. An intermediary-based exchange rate model shows that a higher global IRV increases the uncertainty of future risk-taking and tightens current financial constraints. Position unwinding triggers loss of carry and momentum. Additional empirical results confirm this economic channel. Global IRV risk is also negatively priced in other currency strategies and momentum. The explanatory power is not driven by existing measures of uncertainty or intermediary constraints.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , First View , pp. 1 - 35
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

I would like to thank an anonymous referee, Hendrik Bessembinder (the editor), and Lucio Sarno (a referee) for insightful comments that greatly improved the article. This article is a revised version of Chapter 1 of my doctoral dissertation at Singapore Management University. I am indebted to Thomas Sargent and Jun Yu for their continuous support and guidance on this project. I also thank insightful comments from Pedro Barroso, Geert Bekaert, Tim Bollerslev, Magnus Dahlquist, Philip Dybvig, Dashan Huang, Huichou Huang, Nan Li, John Rogers, Guofu Zhou, and seminar participants at the Central University of Finance and Economics, Fudan University, KWC-CFF (Lund-Gothenburg) Workshop, Nankai University, Peking University HSBC Business School, Renmin University of China, Shanghai Jiao Tong University, Singapore Management University, SWUFE, University of Gothenburg, and Zhejiang University. I am also grateful to Craig Burnside, Jean-S’ebastien Fontaine, Sydney Ludvigson, Asaf Manela, Tyler Muir, and Lucio Sarno for making their data and code available online. Financial support from Jan Wallanders och Tom Hedelius stiftelse samt Tore Browaldhs stiftelse (grant numbers BFh21-0007 and P19-0117) and the Swedish House of Finance is gratefully acknowledged. The previous draft is titled “Currency Carry, Momentum, and U.S. Monetary Policy Uncertainty.” All remaining errors are my own.

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