Common risk factors in cross-sectional FX options returns (2024)

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Volume 28 Issue 3 May 2024
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Xuanchen Zhang

King’s College London

, London WC2B 4BG,

UK

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,

Raymond H Y So

King’s College London

, London WC2B 4BG,

UK

Corresponding author: King’s College London, 30 Aldwych, London WC2B 4BG, UK. Email: raymond.so@kcl.ac.uk

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Tarik Driouchi

King’s College London

, London WC2B 4BG,

UK

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Review of Finance, Volume 28, Issue 3, May 2024, Pages 897–944, https://doi.org/10.1093/rof/rfae002

Published:

18 January 2024

Article history

Received:

09 September 2023

Accepted:

27 December 2023

Published:

18 January 2024

Corrected and typeset:

28 February 2024

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    Xuanchen Zhang, Raymond H Y So, Tarik Driouchi, Common risk factors in cross-sectional FX options returns, Review of Finance, Volume 28, Issue 3, May 2024, Pages 897–944, https://doi.org/10.1093/rof/rfae002

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Abstract

We identify a comprehensive list of thirty-eight characteristics for predicting cross-sectional FX options returns. We find that three factors—long-term straddle momentum, implied volatility, and illiquidity—can generate economically and statistically significant risk premia not explained by other return predictors. Meanwhile, the predictability of the other characteristics becomes insignificant after accounting for the FX option three-factor model. The significance of the three factors is confirmed through a series of robustness tests covering different data sources, alternative options strategies, diversification effects, bootstrapping, and omitting crisis years.

© The Author(s) 2024. Published by Oxford University Press on behalf of the European Finance Association. All rights reserved. For permissions, please email: journals.permissions@oup.com

This article is published and distributed under the terms of the Oxford University Press, Standard Journals Publication Model (https://academic.oup.com/pages/standard-publication-reuse-rights)

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