Business Cycles and Currency Returns
55 Pages Posted: 31 Jan 2017 Last revised: 21 Dec 2018
Date Written: December 18, 2018
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: Suggested Citation