Working Paper: CEPR ID: DP15313
Authors: Tarek Hassan; Tony Zhang
Abstract: This article reviews the literature on currency and country risk with a focus on its macroeconomic origins and implications. A growing body of evidence shows countries with safer currencies enjoy persistently lower interest rates and a lower required return to capital. As a result, they accumulate relatively more capital than countries with currencies international investors perceive as risky. Whereas earlier research focused mainly on the role of currency risk in generating violations of uncovered interest parity and other financial anomalies, more recent evidence points to important implications for the allocation of capital across countries, the efficacy of exchange rate stabilization policies, the sustainability of trade deficits, and the spillovers of shocks across international borders.
Keywords: currency risk; country risk; capital flows; uncovered interest parity; carry trade; forward premium puzzle
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Currency safety (F31) | Interest rates (E43) |
| Currency safety (F31) | Required return to capital (G31) |
| Currency safety (F31) | Capital accumulation (E22) |
| Interest rates (E43) | Capital accumulation (E22) |
| Required return to capital (G31) | Capital accumulation (E22) |
| Currency safety (F31) | Investment behavior (G11) |
| Currency risk premia (F31) | Allocation of capital (G31) |
| Currency risk premia (F31) | Trade deficits (F14) |
| Currency risk premia (F31) | Exchange rate stabilization policies (F31) |
| Interest rates (E43) | Cost of capital (G31) |
| Cost of capital (G31) | Investment behavior (G11) |