Common Risk Factors in Cross-Sectional FX Options Returns

Xuanchen Zhang; Raymond H Y So; Tarik Driouchi

doi:10.1093/rof/rfae002

Common Risk Factors in Cross-Sectional FX Options Returns

Xuanchen Zhang
, Raymond H Y So^*
, Tarik Driouchi

^*Corresponding author for this work

Accounting & Financial Management

Research output: Contribution to journal › Article › peer-review

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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.

Original language	English
Article number	rfae002
Pages (from-to)	897-944
Number of pages	48
Journal	Review of Finance
Volume	28
Issue number	3
Early online date	18 Jan 2024
DOIs	https://doi.org/10.1093/rof/rfae002
Publication status	Published - 1 May 2024

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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.",

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N2 - 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.

AB - 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.

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Common Risk Factors in Cross-Sectional FX Options Returns

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