Currency Risk Factors in a Recursive Multi-Country Economy

77 Pages Posted: 24 Dec 2014 Last revised: 16 May 2017

Riccardo Colacito

University of North Carolina Kenan-Flagler Business School

Mariano Massimiliano Croce

University of North Carolina Kenan-Flagler Business School

Federico Gavazzoni

INSEAD

Robert C. Ready

University of Rochester - Simon Business School

Date Written: May 14, 2017

Abstract

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

Colacito, Riccardo and Croce, Mariano Massimiliano and Gavazzoni, Federico and Ready, Robert C., Currency Risk Factors in a Recursive Multi-Country Economy (May 14, 2017). INSEAD Working Paper No. 2015/40/FIN; Simon Business School Working Paper No. FR 15-10. Available at SSRN: https://ssrn.com/abstract=2542182 or http://dx.doi.org/10.2139/ssrn.2542182

Riccardo Colacito

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

HOME PAGE: http://www.unc.edu/~colacitr

Mariano Massimiliano Croce

University of North Carolina Kenan-Flagler Business School ( email )

McColl Builiding
Chapel Hill, NC North Carolina 27599-3490
United States

HOME PAGE: http://dl.dropboxusercontent.com/u/17690403/mmc_site/public_html/index.htm

Federico Gavazzoni

INSEAD ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France

HOME PAGE: http://federicogavazzoni.com

Robert C. Ready (Contact Author)

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

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