Working Paper: NBER ID: w23773
Authors: Hanno Lustig; Robert J. Richmond
Abstract: We relate the risk characteristics of currencies to measures of physical, cultural, and institutional distance. The currencies of countries which are more distant from other countries are more exposed to systematic currency risk. This is due to a gravity effect in the factor structure of bilateral exchange rates: When a currency appreciates against a basket of all other currencies, its bilateral exchange rate appreciates more against the currencies of distant countries. As a result, currencies of peripheral countries are more exposed to the systematic variation than currencies of central countries. Trade network centrality is the best predictor of a currency’s average exposure to systematic risk.
Keywords: exchange rates; currency risk; gravity effect; systematic risk; bilateral exchange rates
JEL Codes: F31; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| distance (R12) | currency risk exposure (F31) |
| distance (R12) | loading on base factor (C51) |
| shared language (Y80) | loading on base factor (C51) |
| colonial linkages (F54) | loading on base factor (C51) |
| distance (R12) | cross-sectional variation in base factor loadings (C46) |
| distance (R12) | exchange rate movements (F31) |