Momentum in Stock Market Returns, Risk Premia on Foreign Currencies and International Financial Integration

Abstract

Momentum in developed countries' stock market index returns can be exploited to form portfolios of excess returns on foreign currencies as relatively high past foreign stock market returns signal a foreign currency appreciation. Two risk factors extracted from the stock index momentum based currency portfolio returns explain more than 80 percent of their cross-sectional variation. In contrast to currency risk factors constructed from forward discount sorted currency portfolios, these risk factors are not related to business cycle or liquidity risk. But high currency risk premia are associated with relatively deep financial integration and a high level of risk sharing.