Currency Value

We assess the properties of currency value strategies based on real exchange rates in a cross-sectional portfolio setting. We find that real exchange rates predict currency excess returns, but in a way that is inconsistent with the notion of currency value because a high valuation level forecasts a relative appreciation of the foreign currency going forward. However, adjusting real exchange rates for two key country-specific fundamentals -- productivity and the quality of export goods -- generates a measure of currency value which still predicts currency excess returns and is consistent with the spot exchange rate reverting toward fundamental value