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The differential in trailing equity market performance across countries strongly predicts the cross-section of currency returns. This factor produces a statistically significant alpha in excess of traditional carry, trend, and valuation.


Overview

We show that the differential in trailing equity market performance across countries strongly predicts the cross-section of currency returns. Specifically, exchange rates tend to appreciate for countries with the strongest equity returns in the preceding year. Portfolios formed on this factor have outperformed those formed on traditional carry, trend, and valuation factors in currencies since 1990. The equity differential factor cannot be explained by these traditional factors and produces a statistically significant alpha in excess of them. Its performance is remarkably consistent and robust to different formulations. We provide evidence that investor demand for outperforming equity markets probably contributes to this effect.

About the Author(s)

David Turkington
Alireza Yazdani

Alireza Yazdani is vice president at State Street Associates, Cambridge, Massachusetts.

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