Global Risks in the Currency Market

Abstract

Global risks allow theoretical models of the currency market to explain currency risk premia. Yet, there is no consensus in the empirical literature on which factors can represent global risks. We develop an asset pricing test for global risk factors that relies on the key assumption of a distinct U.S. global risk exposure. Using numeraire-invariant test assets that are particularly suitable for studying global risks, we apply the test on a large set of factors used in recent studies of currency risk. We find that only equity market risk can represent a global risk in the currency market.

Keywords: global risk, carry trades, currency returns

JEL Classification: F3, G1