Currency Premia and Global Imbalances
Winner of the Kepos Capital Award for the Best Paper on Investments at the 2013 WFA Meeting
72 Pages Posted: 20 Jun 2013 Last revised: 18 Oct 2017
Date Written: May 18, 2016
We show that a global imbalance risk factor that captures the spread in countries' external imbalances and their propensity to issue external liabilities in foreign currency explains the cross-sectional variation in currency excess returns. The economic intuition is simple: net debtor countries offer a currency risk premium to compensate investors willing to finance negative external imbalances because their currencies depreciate in bad times. This mechanism is consistent with exchange rate theory based on capital flows in imperfect financial markets. We also find that the global imbalance factor is priced in cross sections of other major asset markets.
Keywords: Currency Risk Premium; Global Imbalances; Foreign Exchange Excess Returns; Carry Trade
JEL Classification: F31; F37; G12; G15
Suggested Citation: Suggested Citation