Currency Risk Factors in a Recursive Multi-Country Economy
Journal of Finance, Forthcoming
77 Pages Posted: 24 Dec 2014 Last revised: 5 Dec 2017
Date Written: May 14, 2017
Focusing on the ten countries with the most-traded currencies, we provide novel empirical evidence about the existence of significant heterogenous exposure to global growth news shocks. We incorporate this empirical fact in a frictionless risk-sharing model with recursive preferences, multiple countries, and multiple consumption goods whose supply is subject to both global and local short- and long-run shocks. Since news shocks are priced, heterogenous exposure to global long-run growth shocks results in both a relevant reallocation of international resources and currency adjustments. Our unified framework replicates the properties of the HML-FX and HML-NFA carry trade strategies studied by Lustig et al. (2011) and Della Corte et al. (2013).
Keywords: Recursive Risk Sharing, Carry Trade, Currency Risk Factors
JEL Classification: C62, F31, G12
Suggested Citation: Suggested Citation