Abstract/Summary

The thesis consists of eleven published papers and begins with a Contextual chapter that provides an overview of the papers. This is followed by the individual papers grouped into three broad chapters, namely, Choice of numéraire for exchange rate models (three papers), Frankel-Wei regression framework, choice of common numéraire, and implied betas (three papers), and Generalisation of currency rates with respect to other asset classes (five papers). The thesis ends with a Conclusion chapter. The specific focus of the thesis is on the choice of numéraire and the numéraire effect in the currency market, where currencies can be priced relative to different numéraires. The numéraire choice is between single-currency numéraires and multicurrency numéraires. For example, bilateral exchange rates have single-currency numéraires and multilateral exchange rates have multicurrency numéraires. More generally, the scope of the thesis widened to the choice of numéraire and the numéraire effect in other asset classes, such as precious metals, oil, and equities, which are usually priced relative to single-currency numéraires. For example, precious metals and oil are typically priced in US dollars, and equities are typically priced in their local currencies. The main contributions of the eleven papers are: to compare different numéraires, to provide methods to estimate, and remove, the numéraire effect; and to highlight the impact of the numéraire effect. Most papers separate the numéraire from an asset’s price. For single-currency numéraires, the numéraire is proxied with a relative currency rate, and for multicurrency numéraires, the numéraire is proxied with a portfolio of relative currency rates. The separation allows researchers to measure the numéraire effect, decompose estimators of regression coefficients, test for aggregation bias, and test the significance of hedge ratios. In summary, many of the papers show that the choice of numéraire matters and that the numéraire effect can have a significant impact on estimators, results, interpretations, and conclusions. To accurately measure the relationship between two assets it is recommended that researchers use a multicurrency numéraire that consists of a well-diversified basket of currencies.