Review of Financial Studies Vol. 29 No. 8 2016

Currency Premia and Global Imbalances

Pasquale Della Corte^1,2,3; Steven Riddiough^1,2,3; Lucio Sarno^1,2,3

¹ The University of Melbourne · ² City, University of London · ³ Imperial College London

Abstract

We show that a global imbalance risk factor that captures the spread in countries’ external imbalances and their propensity to issue external liabilities in foreign currency explains the cross-sectional variation in currency excess returns. The economic intuition is simple: net debtor countries offer a currency risk premium to compensate investors willing to finance negative external imbalances because their currencies depreciate in bad times. This mechanism is consistent with exchange rate theory based on capital flows in imperfect financial markets. We also find that the global imbalance factor is priced in cross-sections of other major asset markets.

DOI

10.1093/rfs/hhw038

Volume

29

Issue

8

Pages

2161-2193

Language

en

Sources

openalex crossref

Cite

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