Uncovered Interest Rate Parity: A Relation to Global Trade Risk

48 Pages Posted: 6 Oct 2015 Last revised: 24 Jan 2018

See all articles by Andreea Constantin

Andreea Constantin

University of Lausanne, HEC, IBF

Tamara Nunes

University of Lausanne

Date Written: March 5, 2017

Abstract

The paper gives evidence of a novel pricing factor for the cross-section of carry trade returns based on trade relations between countries. In particular, we apply network theory on countries' bilateral trade to construct a measure for countries' exposure to a global trade risk. A high level of exposure to global trade risk implies that the economic activity in one country is highly dependent on the economic activity of its trade partners and on aggregate trade flow, which reflects in carry trade returns. We find empirically that low interest rate currencies are seen by investors as a hedge against global trade risk while high interest rate currencies deliver low returns when global trade risk is high. These results provide evidence on the underlying macroeconomic sources of systematic risk in currency markets.

Keywords: exchange rates, uncovered interest rate parity, trade network, global trade risk, asset pricing

JEL Classification: F31, F10, G12, G15, L14

Suggested Citation

Constantin, Andreea and Nunes, Tamara, Uncovered Interest Rate Parity: A Relation to Global Trade Risk (March 5, 2017). Available at SSRN: https://ssrn.com/abstract=2669454 or http://dx.doi.org/10.2139/ssrn.2669454

Andreea Constantin

University of Lausanne, HEC, IBF ( email )

CH-1015 Lausanne
Switzerland

Tamara Nunes (Contact Author)

University of Lausanne ( email )

Quartier Chambronne
Lausanne, Vaud CH-1015
Switzerland

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