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Commodity Trade and the Carry Trade: A Tale of Two Countries

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  • ROBERT READY
  • NIKOLAI ROUSSANOV
  • COLIN WARD

Abstract

Persistent interest rate differentials account for much of the currency carry trade profitability. “Commodity currencies†offer high interest rates on average, while countries that export finished goods tend to have low interest rates. We develop a general equilibrium model of international trade and currency pricing where countries have an advantage in producing either basic inputs or final goods. In the model, domestic production insulates commodity†producing countries from global productivity shocks, forcing final†good producers to absorb them. Commodity†currency exchange rates and risk premia increase with productivity differentials and trade frictions. These predictions are strongly supported in the data.

Suggested Citation

  • Robert Ready & Nikolai Roussanov & Colin Ward, 2017. "Commodity Trade and the Carry Trade: A Tale of Two Countries," Journal of Finance, American Finance Association, vol. 72(6), pages 2629-2684, December.
  • Handle: RePEc:bla:jfinan:v:72:y:2017:i:6:p:2629-2684
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    File URL: https://doi.org/10.1111/jofi.12546
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Hassan, Tarek & Mano, Rui C., 2014. "Forward and Spot Exchange Rates in a Multi-currency World," CEPR Discussion Papers 10060, C.E.P.R. Discussion Papers.
    2. Malamud, Semyon & Schrimpf, Andreas, 2018. "An Intermediation-Based Model of Exchange Rates," CEPR Discussion Papers 13182, C.E.P.R. Discussion Papers.
    3. Hanno Lustig & Robert J. Richmond, 2017. "Gravity in FX R-Squared: Understanding the Factor Structure in Exchange Rates," NBER Working Papers 23773, National Bureau of Economic Research, Inc.
    4. Guglielmo Maria Caporale & Michael Donadelli & Alessia Varani, 2014. "International Capital Markets Structure, Preferences and Puzzles: The US-China Case," Discussion Papers of DIW Berlin 1362, DIW Berlin, German Institute for Economic Research.
    5. Aloosh, Arash & Bekaert, Geert, 2019. "Currency Factors," CEPR Discussion Papers 13464, C.E.P.R. Discussion Papers.
    6. Weithing Zhang & Thomas Mertens & Tarek Hassan, 2014. "Currency Manipulation," 2014 Meeting Papers 401, Society for Economic Dynamics.
    7. Hassan, Tarek A. & Mertens, Thomas M. & Zhang, Tony, 2016. "Not so disconnected: Exchange rates and the capital stock," Journal of International Economics, Elsevier, vol. 99(S1), pages 43-57.
    8. repec:dau:papers:123456789/15216 is not listed on IDEAS
    9. Evgenia Passari, 2015. "Commodity Currencies Revisited," Post-Print hal-01453266, HAL.
    10. repec:eee:jfinec:v:131:y:2019:i:2:p:433-455 is not listed on IDEAS
    11. Bekaert, Geert & Panayotov, George, 2019. "Good Carry, Bad Carry," CEPR Discussion Papers 13463, C.E.P.R. Discussion Papers.
    12. Caporale, Guglielmo Maria & Donadelli, Michael & Varani, Alessia, 2015. "International capital markets structure, preferences and puzzles: A “US–China World”," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 36(C), pages 85-99.
    13. Robert Ready & Mariano Croce & Federico Gavazzoni & Riccardo Colacito, 2016. "Currency Risk Factors in a Recursive Multi-Country Economy," 2016 Meeting Papers 297, Society for Economic Dynamics.
    14. Colacito, Riccardo & Croce, Mariano Massimiliano & Ho, Steven & Howard, Philip, 2018. "BKK the EZ Way. International Long-Run Growth News and Capital Flows," CEPR Discussion Papers 12783, C.E.P.R. Discussion Papers.
    15. Yang Liu & Mariano Croce & Ivan Shaliastovich & Ric Colacito, 2016. "Volatility Risk Pass-Through," 2016 Meeting Papers 135, Society for Economic Dynamics.
    16. Lu, Helen & Jacobsen, Ben, 2016. "Cross-asset return predictability: Carry trades, stocks and commodities," Journal of International Money and Finance, Elsevier, vol. 64(C), pages 62-87.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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