Business Cycles and Currency Returns

55 Pages Posted: 31 Jan 2017 Last revised: 21 Dec 2018

See all articles by Ric Colacito

Ric Colacito

University of North Carolina Kenan-Flagler Business School

Steven J. Riddiough

University of Melbourne

Lucio Sarno

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

Date Written: December 18, 2018

Abstract

We find a strong link between currency returns and the relative strength of the business cycle. Buying currencies of strong economies and selling currencies of weak economies generates high returns both in the cross section and time series of countries. These returns stem primarily from spot exchange rate predictability, are uncorrelated with common currency strategies, and cannot be understood using traditional risk factors. We also show that a business cycle factor implied by our results is priced in a broad currency cross section. Finally, we propose a mechanism that generates these facts using an international macro-finance model with long-run risk.

Keywords: exchange rates; currency risk premium; business cycles; long-run risk.

JEL Classification: F31, G12, G15

Suggested Citation

Colacito, Riccardo and Riddiough, Steven J. and Sarno, Lucio, Business Cycles and Currency Returns (December 18, 2018). Available at SSRN: https://ssrn.com/abstract=2906600 or http://dx.doi.org/10.2139/ssrn.2906600

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

Steven J. 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)

HOME PAGE: http://www.stevenriddiough.com

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)

London
United Kingdom

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