Return Spillovers Between Currency Factors

Abstract

In this paper we suggest that currency factors carry informational value by disentangling the effect each currency has on exchange rate dynamics. First, we confirm the existence of a geographical factor driving American, European and Pacific exchange rates. Second, we reveal two novel stylized facts: 1) The euro and swiss franc factors are highly correlated and exposed, serving as major channels of shock propagation from and to other currencies; 2) The pound factor and, to some extent, the yen factor are the most secluded in the G10 network and have been net absorbers of spillovers from other currencies. Finally, we show that aggregate currency return spillovers peak in consonance with key economic and financial events.