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Business & Finance Series: Research Spotlight

New research from Cass examines what stock markets can tell us about exchange rates

Recent research by academics at the Cass Business School, the Bank of England and City University Hong Kong used data for more than 40 markets observed over 30 years to show that average returns of up to 12% per annum are available to those allocating assets across international stock markets.


The authors of the working paper – Richard Payne, Lucio Sarno, both professors at Cass Business School, as well as Gino Cenedese and Giorgio Valente – focus on the extent to which movements in exchange rates might erode predictable movements in international stock markets and show that there is effectively no such erosion. This leaves significant returns available to investors allocating money across global stock markets when returns are measured in an investor’s home currency. The result also means that predictable movements in stock markets are of no use in predicting exchange rate movements.

The work, published as a Bank of England working paper and forthcoming in the Review of Finance, goes on to show that the returns available to international investors cannot be wholly explained as compensation for bearing stock market or currency market risk and are not explained away by transaction costs. The strategy’s returns are also uncorrelated with those from existing, well-known international investment strategies (e.g. FX carry) and thus may provide a nice complement to international portfolios based on those traditional lines.

Professor Payne commented that “The punchline of the first part of the paper is that if, for example, you are confident that the Japanese stock market is going to rise relative to the UK stock market, this tells you nothing about movements in the JPY relative to the GBP. So the correlation between stock market returns and currency returns is roughly zero in the cross-section.”

Professor Sarno further explained that “the fact that movements in exchange rates don’t wipe out predictable movements in equity market returns means that there is money on the table for global investors and this is true if you use raw returns or if you compute risk-adjusted returns.”

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