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Currency Premia and Global Imbalances

Winner of the Kepos Capital Award for the Best Paper on Investments at the 2013 WFA Meeting

28th Australasian Finance and Banking Conference

72 Pages Posted: 20 Jun 2013 Last revised: 18 Oct 2017

Pasquale Della Corte

Imperial College London; Centre for Economic Policy Research (CEPR)

Steven J. Riddiough

University of Melbourne

Lucio Sarno

City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: May 18, 2016

Abstract

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

Della Corte, Pasquale and Riddiough, Steven J. and Sarno, Lucio, Currency Premia and Global Imbalances (May 18, 2016). Winner of the Kepos Capital Award for the Best Paper on Investments at the 2013 WFA Meeting; 28th Australasian Finance and Banking Conference. Available at SSRN: https://ssrn.com/abstract=2280952 or http://dx.doi.org/10.2139/ssrn.2280952

Pasquale Della Corte

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, SW7 2AZ
United Kingdom
+44(0)20 759 49331 (Phone)

HOME PAGE: http://https://sites.google.com/site/pasqualedellacorte/

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Steven Riddiough (Contact Author)

University of Melbourne ( email )

Faculty of Business and Economics
Level 12 198 Berkeley Street
Melbourne, Victoria 3010
Australia
+61 (0)3834 40044 (Phone)

Lucio Sarno

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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