Common risk factors in cross-sectional FX options returns

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 b...

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Bibliographic Details
Published in:Review of Finance 2024-05, Vol.28 (3), p.897-944
Main Authors: Zhang, Xuanchen, So, Raymond H Y, Driouchi, Tarik
Format: Article
Language:English
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Summary: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.
ISSN:1572-3097
1573-692X
1875-824X
DOI:10.1093/rof/rfae002