Fiscal Cyclicality and Currency Risk Premia
50 Pages Posted: 25 Oct 2017 Last revised: 14 Aug 2019
Date Written: April 7, 2019
I uncover the government fiscal condition as an economic source of exchange rate fluctuations and currency risk premia. Resting on an asset pricing logic, I evaluate currencies as claims to government primary surpluses. A country's currency appreciates when its government surpluses increase. Moreover, as government surpluses load on a common factor, countries whose government surpluses are more exposed to this factor have higher currency risk premia. Their currency returns are also more exposed to the carry trade return, leading to a correspondence between the factor structure in fiscal conditions and the factor structure in currency returns.
(Appendix is available at: https://ssrn.com/abstract=3077657.)
Keywords: Nominal Exchange Rate, Currency Risk Premium, Government Surplus
JEL Classification: E42, F31, G15
Suggested Citation: Suggested Citation