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Čt 03.10.2024

Mykola Babiak (Lancaster University Management School) "Currency Network Risk"

Prof. Mykola Babiak

Lancaster University Management School, United Kingdom

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Authors: Mykola Babiak, Jozef Baruník

Abstract: This paper identifies a new currency risk stemming from linkages between option-implied currency volatilities. A volatility network strategy that buys net recipients and sells net transmitters of transitory shocks to ex-ante currency volatilities generates significant excess returns. Net recipients are more exposed to volatility spillovers and compensate investors with higher average returns. In contrast, net transmitters are more resilient to volatility transmissions and offer a lower risk premium because they hedge against volatility interdependencies. When volatility linkages are controlled for contemporaneous correlations, the strategy is uncorrelated with popular benchmarks. The volatility network factor is also priced in a currency cross-section. 

JEL Classification: G12, G15, F31
Keywords: Currency predictability, network risk, currency volatility, option-implied volatility, persistence, term structure

Full Text: Currency Network Risk