Base Currency Risk (Edward Conway, 2015).
Abstract (Full text bcr.pdf)
Currency risk is all-pervasive in finance and economics, as all financial observations are denominated in risky base currencies. This paper presents a new currency independent numeraire based on: (i) no arbitrage, (ii) equal treatment of all assets, and (iii) recognition of base currencies as assets. This generalises existing theory and reinterprets many empirical phenomena as artefacts of arbitrary base currency choice. It is shown that: increased asset volatility coincides with increased correlation between assets; aggregate spot and forward yields are zero; forward prices are biased predictors of future spot prices; and, unaccounted base currency risk explains the Equity Risk Premium Puzzle. A high correlation between the US dollar and US consumption is identified, and this results in US dollar prices approximating a numeraire under which consumption-based asset pricing fails unless log-utility holds. We hypothesise that this correlation is due to widespread pegging of US income and expenditure to US dollar denominated constants.

BibTeX Citation

@misc{Bcr,
   author = "Conway, E.",
   title = "Base Currency Risk",
   year = "2015",
   url = "http://bcr.edwardconway.net"
 }

Trusted Timestamp
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