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)
University of Minnesota - Carlson School of Management
January 13, 2016
Journal of Finance, Forthcoming
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
Date posted: July 28, 2012 ; Last revised: April 29, 2016
© 2016 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollobot1 in 0.250 seconds