Currency Returns and Fundamental Sources of Risk

Currency Returns and Fundamental Sources of Risk

• Author
• GIULIANO DE QUEIROZ FERREIRA
• Co-authors
• Alex Ferreira , Miguel Leon-Ledesma , Rory Mullen
• Abstract

• We present evidence that uncertainty regarding to investment-specific technology, the marginal efficiency of investment, and the growth of money stock are the key sources of currency risk. We develop an open-economy DSGE model in which these three processes become risk factors that drive currency excess returns. These new factors prove to be empirically relevant for pricing currency excess returns. The risk prices associated with these factors are positive and significant. We find that currencies from countries with low levels of investment-specific technology processes, low levels of the marginal efficiency of the investment process, and high money growth rates earn higher excess returns. Furthermore, we show that currencies from countries with low exposure to the global component of the three processes earn higher excess returns. Our empirical evidence accounts for both the cross-section of average excess returns (portfolios) and individual currency payoffs with the US Dollar. We also reveal a downward trend in the carry trade return over the period 1980 to 2019.

   

   

• Keywords
• carry trade, business cycles, consumption growth, exchange rates, currency risk
• Subject Area
• Asset pricing, investments, and Derivatives

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