Dissecting Currency Momentum

Abstract

This paper shows that currency momentum, which cannot be explained by carry and dollar factors, summarizes the autocorrelation of these factors. Carry and dollar factors are strongly autocorrelated and only earn significantly positive excess returns following positive factor returns. Currency momentum longs the factors following positive factor returns and shorts them following losses. Factor momentum not only outperforms currency momentum but also explains it, whereas idiosyncratic returns do not contain or explain momentum. Further evidence shows that factor momentum is inconsistent with the time-varying risk premium but supports mispricing. In particular, the mispricing prevails across markets.