International Correlation Risk
نویسندگان
چکیده
We document that cross-sectional FX correlation dispersion is countercyclical, as FX pairs with high average correlation become more correlated in bad times whereas pairs with low average correlation become less correlated. We show that currencies that perform badly (well) during periods of high crosssectional disparity in conditional FX correlation yield high (low) average excess returns, suggesting that correlation risk is priced in currency markets. Furthermore, we find a negative cross-sectional relationship between average FX correlations and average option-implied FX correlation risk premia. Finally, we propose a no-arbitrage model that features unspanned FX correlation risk to jointly match the properties of FX correlations and correlation risk premia.
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