Working Paper: NBER ID: w19371
Authors: Robert Ready; Nikolai Roussanov; Colin Ward
Abstract: Persistent differences in interest rates across countries account for much of the profitability of currency carry trade strategies. "Commodity currencies'' tend to have high interest rates while low interest rate currencies belong to exporters of finished goods. This pattern arises in a complete-markets model with trade specialization and limited shipping capacity, whereby commodity-producing countries are insulated from global productivity shocks, which are absorbed by the final goods producers. Empirically, a commodity-based strategy explains a substantial portion of the carry-trade risk premia, and all of their pro-cyclical predictability with commodity prices and shipping costs, as predicted by the model.
Keywords: Commodity Trade; Carry Trade; Interest Rates; Risk Premia; Trade Costs
JEL Codes: F31; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Countries that specialize in exporting basic commodities (F10) | higher average interest rates (E43) |
| Consumption risk associated with trade costs (F12) | higher average interest rates in commodity-producing countries (Q02) |
| Consumption of commodity countries is less risky (E21) | higher average interest rates in commodity countries (Q02) |
| Sorting currencies based on net exports (F31) | significant spreads in average excess returns (G12) |
| Carry trade returns (G15) | positively correlated with commodity price changes (Q02) |
| Carry trade returns (G15) | positively correlated with shipping costs (L87) |
| High trade costs (F12) | especially high conditional expected returns on commodity currency carry trade (G15) |
| Model can account for observed interest rate differentials (E43) | without overstating consumption growth volatility (F62) |