Currency downside risk and macroeconomic variables
Some currencies persistently move together with the stock market and crash in periods of market downturns or high volatility, while others serve as a “safe haven”. In this paper, I study whether or not countries’ macroeconomic characteristics are systematically related to the market risk of their currencies. I find that the market risk is not random, especially on the downside, and it can be predicted by macroeconomic variables. Moreover, the market risk has increased significantly since the 2000s, and its predictability also increased. The real interest rate has the highest explanatory power in accounting for the cross-section of currency market risk. Currencies of countries with high local real interest rates have high market betas, especially downside betas, while low real interest rate currencies are immune to stock market changes. Nominal interest rates also have some explanatory power, but only to the extent to which they correlate with the real interest rates. Other variables considered seem to be irrelevant.