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Asper Assistant Professor published in the Journal of Financial Economics

International research collaboration explores tail risk premiums in the foreign exchange market

May 13, 2021 — 

Dr. Zhenzhen Fan, an Assistant Professor in Finance and Economics at the Asper School of Business recently learned that her paper entitled, Equity Trail Risk and Currency Risk Premiums was accepted for publication by Journal of Financial Economics (JFE), a leading peer-reviewed academic journal covering theoretical and empirical topics in financial economics. Dr. Fan co-authored this paper along with Dr. Juan M. Londono, Senior Economic Project Manager of the US Board of Governors of the Federal Reserve System, and Dr. Xiao Xiao, Assistant Professor of Finance at Amsterdam Business School, University of Amsterdam.

Fan, Londono and Xiao’s research found that currencies that appreciate during equity market turmoil offer lower returns than those that depreciate during equity market turmoil. They construct a global tail risk factor by buying the latter and selling the former and show that this factor explains some of the pronounced currency anomalies.

“Crash risks are very hard to pin down in historical data, especially for currencies where intraday data is rarely available,” said Fan. “One important contribution of our paper is to extract such a systematic tail factor from equity index options. It turns out that this factor is key to understanding some long-lasting puzzles in the foreign exchange market.”

In 2018, Fan said she came up with the preliminary idea on tail risk and currencies and proposed this to her co-authors. After their proposal to the Canadian Derivatives Institute was approved for funding, they went right into developing the research method.

“We had to adjust the research question several times according to the empirical results we got,” said Fan. “The eventual research question explored in the paper turned out to be very different from our initial proposal.”

The team’s first draft came out in June 2019. In 2020, they started presenting their paper at the China International Conference in Finance in Guangzhou (China), Vienna symposium on foreign exchange markets, the American Finance Association Annual Meeting in San Diego (US), the Midwest Finance Association Annual Meeting (virtual), and HEC Montreal CDI seminar (Canada). This experience helped Fan, Londono, and Xiao collect comments to help revise their paper before submitting it to the Journal of Financial Economics in May 2020. After several rounds of revisions, Equity Trail Risk and Currency Risk Premiums was accepted for publication in April 2021.

This is Dr. Fan’s second major international publication in less than a year.  In late 2020, her paper Moment Risk Premia and Stock Return Predictability published in the Journal of Financial and Quantitative Analysis (JFQA).

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