Working Paper: NBER ID: w26299
Authors: Riccardo Colacito; Steven J. Riddiough; Lucio Sarno
Abstract: We find a strong link between currency excess returns and the relative strength of the business cycle. Buying currencies of strong economies and selling currencies of weak economies generates high returns both in the cross section and time series of countries. These returns stem primarily from spot exchange rate predictability, are uncorrelated with common currency investment strategies, and cannot be understood using traditional currency risk factors in either unconditional or conditional asset pricing tests. We also show that a business cycle factor implied by our results is priced in a broad currency cross section.
Keywords: Currency Returns; Business Cycles; Asset Pricing
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 |
|---|---|
| business cycles (E32) | currency excess returns (F31) |
| higher output gaps (E23) | higher currency excess returns (F31) |
| sorting currencies by output gaps (F31) | higher excess returns (G19) |
| business cycle factor (E32) | priced in currency cross-section (F31) |
| business cycles (E32) | compensation for risk associated with currency returns (F31) |