Commodity Trade and the Carry Trade: A Tale of Two Countries
76 Pages Posted: 28 Jul 2012 Last revised: 11 Aug 2020
Date Written: February 1, 2017
Persistent interest rate differentials account for much of the currency carry trade profitability. "Commodity currencies" offer high interest rates on average, while countries that export finished goods tend to have low interest rates. We develop a general equilibrium model of international trade and currency pricing where countries have an advantage in producing either basic inputs or final goods. In the model domestic production insulates commodity-producing countries from global productivity shocks, forcing final-good producers to absorb them. Commodity-currency exchange rates and risk premia increase with productivity differentials and trade frictions. These predictions are strongly supported in the data.
Keywords: currency risk premia, international trade, commodity markets, return predictability, Baltic Dry Index
JEL Classification: E44, F31, G15
Suggested Citation: Suggested Citation