ABSTRACT Persistent interest rate differentials account for much of the currency carry trade profitability. “Commodity currencies” offer high interest rates on average, while countries that export finished goods tend to have low interest rates. We develop a general equilibrium model of international trade and currency pricing where countries have an advantage in producing either basic inputs or final goods. In the model, domestic production insulates commodity‐producing countries from global productivity shocks, forcing final‐good producers to absorb them. Commodity‐currency exchange rates and risk premia increase with productivity differentials and trade frictions. These predictions are strongly supported in the data.

ABSTRACT Focusing on the 10 most traded currencies, we provide empirical evidence regarding a significant heterogeneous exposure to global growth news shocks. We incorporate this empirical fact in a frictionless risk‐sharing model with recursive preferences, multiple countries, and multiple consumption goods whose supply features both global and local short‐ and long‐run shocks. Since news shocks are priced, heterogeneous exposure to long‐lasting global growth shocks results in a relevant reallocation of international resources and currency adjustments. Our unified framework replicates the properties of the HML‐FX and HML‐NFA carry‐trade strategies studied by Lustig, Roussanov, and Verdelhan and Della Corte, Riddiough, and Sarno.