A Fundamental FX Factor Model

I’ve been reading The Elements of Quantitative Investing to branch out from my usual high-frequency finance to something slower or mid-frequency. Factor models are a big part of this quant topic, and I’m trying to get a deeper understanding by following the book and applying the process to FX data. Enjoy these types of posts? Then you should sign up for my newsletter. Factor models provide a mechanism for explaining returns. They are multivariate models that break down the features that drive an asset’s performance. The key assumption is that each individual asset’s return is not independent of the others, but there are common factors that drive returns and an asset’s sensitivity to those factors drives its returns. In equities, you’ll hear of value and momentum factors, and there are even ETFs that you can invest in for exposure to those factors. We want to come up with something similar in the FX space. A factor model attempts to explain asset-universe return behaviour. From this…