Macro factors PCA model on Korean-won based currency portfolio premia

Abstract

This paper analyzes the impact of domestic and global macroeconomic factors on the returns of portfolios that mimic value and momentum strategy and carry trade strategy. The large-scale data of 200 macro-economic and financial variables were used to predict the returns. The risk premium of the value and momentum foreign exchange trading strategy was significantly predicted by the US interest rate and global stock market return. Among other macroeconomic indicators, US interest rates have a big impact on manipulating risk appetite around the world

as the volume of trading on a stock market increases, so does the demand for the currency in that country. On the other hand, it is confirmed that the carry trade strategy premium using the disparity in interest rates of cross-sectional countries is dominated by changes in domestic international trade accounts and employment indicators. This is because the interest rate is mainly determined by the monetary policy of the Bank of Korea after examining the strength of the domestic economy. The result of forecast from comprehensive domestic and foreign macroeconomic factors, which optimally selects one of the two FX strategies by catching a signal of positive return for next month, provides better performance of payoff than equally weighted investment to both FX strategies.