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Currency Premia and Global Imbalances

Della Corte, P., Riddiough, S. J. and Sarno, L. (2016). Currency Premia and Global Imbalances. Review of Financial Studies, 29(8), pp. 2161-2193. doi: 10.1093/rfs/hhw038

Abstract

We show that a global imbalance risk factor that captures the spread in countries' external imbalances and their propensity to issue external liabilities in foreign currency explains the cross-sectional variation in currency excess returns. The economic intuition is simple: net debtor countries offer a currency risk premium to compensate investors willing to finance negative external imbalances because their currencies depreciate in bad times. This mechanism is consistent with exchange rate theory based on capital flows in imperfect financial markets. We also find that the global imbalance factor is priced in cross sections of other major asset markets.

Publication Type: Article
Additional Information: Copyright Cambridge Journals, 2016. Reprinted with permission.
Publisher Keywords: Currency Risk Premium; Global Imbalances; Foreign Exchange Excess Returns; Carry Trade
Subjects: H Social Sciences > HG Finance
Departments: Cass Business School
URI: http://openaccess.city.ac.uk/id/eprint/13287
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