We examine the pricing of a horizon specific uncertainty network risk, extracted from option implied variances on exchange rates, in the cross-section of currency returns. Buying currencies that are receivers and selling currencies that are transmitters of short-term shocks exhibits a high Sharpe ratioand yields a significant alpha when controlling for standard dollar, carry trade, volatility, variance risk premium and momentum strategies. This profitability stems primarily from the causal nature of shock propagation and not from contemporaneous dynamics. Shock propagation at longer horizons is priced less, indicating a downward-sloping term structure of uncertainty network riskin currency markets .
This paper identifies new currency risk stemming from a network of idiosyncratic option-based currency volatilities and shows how such network risk is priced in the cross-section of currency returns. A portfolio that buys net-receivers and sells net-transmitters of short-term linkages between currency volatilities generates a significant Sharpe ratio. The network strategy formed on causal connections is uncorrelated with popular benchmarks and generates a significant alpha , while network returns formed on aggregate connections, which are driven by a strong correlation component, are partially subsumed by standard factors. Long-term linkages are priced less, indicating a downward-sloping term structure of network risk .
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We examine the pricing of a horizon specific uncertainty network risk, extracted from option implied variances on exchange rates,
This paper identifies new currency risk stemming from a network of idiosyncratic option-based currency volatilities and shows how such network risk is priced
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Buying currencies that are receivers and selling currencies that are transmitters
A portfolio that buys net-receivers and sells net-transmitters
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shocks exhibits a high Sharpe ratioand yields
linkages between currency volatilities generates a significant Sharpe ratio. The network strategy formed on causal connections is uncorrelated with popular benchmarks and generates
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when controlling for standard dollar, carry trade, volatility, variance risk premium and momentum strategies. This profitability stems primarily from the causal nature of shock propagation and not from contemporaneous dynamics. Shock propagation at longer horizons is
, while network returns formed on aggregate connections, which are driven by a strong correlation component, are partially subsumed by standard factors. Long-term linkages are
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uncertainty network riskin currency markets
network risk