From Risk Factors to Networks: A Case Study on Interconnectedness Using Currency Funds

Abstract

In this article, the authors introduce a combined approach for investigating currency funds by using methods from network science and risk factor analysis. They document a positive relationship between currency funds’ style exposure, fund age, size, and connectedness, providing both economically and statistically significant results. The most important funds in the network can influence the currency market with significant exposure to the risk factors’ carry, value, and trend. In general, the authors’ approach helps investors to identify market interconnectedness; shows how risk can be transmitted; and highlights the factors that could represent significant idiosyncratic, systematic, and systemic economic risk. The authors argue that the interconnectedness is asymmetrical and the network is reciprocal. There are funds with significant importance scores. They provide a framework for practical implementation.

TOPICS: Currency, analysis of individual factors/risk premia, statistical methods, risk management