The Trade Imbalance Network and Currency Returns
77 Pages Posted: 9 Aug 2023 Last revised: 19 Apr 2024
Date Written: April 18, 2024
Abstract
We extend the theory of Gabaix and Maggiori (2015) to study currency risk premia in a multi-country world with imperfect financial markets. Currency returns are connected to financiers’
limited commitment, captured by the complexity of their balance sheets in the trade imbalance
network. Guided by the theory, we construct a Centrality Based Characteristic (CBC), based on
the centrality of the imbalance network and variance-covariance of currency returns. Sorting
currencies on CBC generates a high Sharpe ratio, and the resulting excess returns cannot be
explained by standard currency factors and intermediary asset pricing factors, suggesting a
novel source of currency predictability
Keywords: Trade imbalance network, Currency premia, Carry trade, Network centrality
JEL Classification: F31, F37, G12, G15
Suggested Citation: Suggested Citation