Currency Speculation

Capital flows between countries or areas with independent monies occur in the context of exchange risk. A key issue in the study of global capital flows is how rational investors (and borrowers) deal with such risk. Currency risk is not always a source of friction (or in economics jargon, disutility). In some cases investors can gain protection against specific bad “states of the world” by deliberately assuming currency risks. An illustration is the once renowned role of the Swiss franc as safe haven – rising at times of global financial distress or raised international tension. In other cases, investors can expect to bolster their returns considerably by increasing their exchange risk exposure even without possessing the proverbial crystal ball. Borrowers might similarly expect to reduce their financing costs (by assuming currency risk). Finally there are a range of players who believe that for some reason they possess special insight which will enable them to make profits at the expense of less skilful players in the game of currency speculation (or at the expense of non-players who have embraced a so-called passive strategy, discussed below).