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Fiscal Cyclicality and Currency Risk Premia

Author

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  • Zhengyang Jiang

Abstract

I develop a model of real exchange rate determination that attributes a central role to the intertemporal government budget condition, which equates the market value of government debt to the present value of government surpluses. To enforce this equilibrium condition in the presence of nominal rigidities, the real exchange rate has to adjust in response to shocks to government surpluses. The model predicts that fiscal shocks account for real exchange rate movements, and the factor structure in fiscal shocks aligns with the factor structure in currency returns. Both predictions are confirmed in the sample of developed countries.

Suggested Citation

  • Zhengyang Jiang, 2022. "Fiscal Cyclicality and Currency Risk Premia," The Review of Financial Studies, Society for Financial Studies, vol. 35(3), pages 1527-1552.
    • Handle: RePEc:oup:rfinst:v:35:y:2022:i:3:p:1527-1552.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhab061
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    Cited by:

    1. Liu, Yang, 2023. "Government debt and risk premia," Journal of Monetary Economics, Elsevier, vol. 136(C), pages 18-34.
    2. Peter Hördahl & Giorgio Valente, 2022. "Emerging market bond flows and exchange rate returns," BIS Working Papers 1042, Bank for International Settlements.
    3. Jiang, Zhengyang & Richmond, Robert J., 2023. "Origins of international factor structures," Journal of Financial Economics, Elsevier, vol. 147(1), pages 1-26.

    More about this item

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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