Abstract

http://ssrn.com/abstract=2118239
 
 

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Commodity Trade and the Carry Trade: A Tale of Two Countries


Robert C. Ready


University of Rochester - Simon Business School

Nikolai L. Roussanov


University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Colin Ward


University of Minnesota - Carlson School of Management

January 13, 2016

Journal of Finance, Forthcoming

Abstract:     
Persistent differences in interest rates across countries account for much of the profitability of currency carry trade strategies. The high interest rate "investment" currencies tend to be "commodity currencies," while low interest rate "funding" currencies tend to belong to countries that export finished goods and import most of their commodities. We develop a general equilibrium model of international trade and currency pricing in which countries have an advantage in producing either basic input goods or final consumable goods. The model predicts that commodity-producing countries are insulated from global productivity shocks through a combination of trade frictions and domestic production, while the final good producers that drive the global business cycle also absorb the shocks. As a result, the commodity country currency is risky as it tends to depreciate in bad times, yet has higher interest rates on average due to lower precautionary demand, compared to the final good producer. The carry trade risk premium increases in the degree of specialization, and the real exchange rate tracks relative technological productivity of the two countries. The model's predictions are strongly supported in the data.

Number of Pages in PDF File: 87

Keywords: currency risk premia, international trade, commodity markets, return predictability, Baltic Dry Index

JEL Classification: E44, F31, G15


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Date posted: July 28, 2012 ; Last revised: April 29, 2016

Suggested Citation

Ready, Robert C. and Roussanov, Nikolai L. and Ward, Colin, Commodity Trade and the Carry Trade: A Tale of Two Countries (January 13, 2016). Journal of Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2118239 or http://dx.doi.org/10.2139/ssrn.2118239

Contact Information

Robert C. Ready
University of Rochester - Simon Business School ( email )
Rochester, NY 14627
United States

Nikolai L. Roussanov (Contact Author)
University of Pennsylvania - The Wharton School ( email )
3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Colin Ward
University of Minnesota - Carlson School of Management ( email )
Carlson School of Management
321 19th Avenue South
Minneapolis, MN 55455
United States
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