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Business Cycles and Currency Returns

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  • Colacito, Ric
  • Riddiough, Steven
  • Sarno, Lucio

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.

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  • Colacito, Ric & Riddiough, Steven & Sarno, Lucio, 2019. "Business Cycles and Currency Returns," CEPR Discussion Papers 14015, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:14015
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    Cited by:

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    3. Mykola Babiak & Jozef Barunik, 2021. "Currency Network Risk," Papers 2101.09738, arXiv.org, revised Jul 2021.
    4. Dupuy, Philippe, 2021. "Risk-adjusted return managed carry trade," Journal of Banking & Finance, Elsevier, vol. 129(C).
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    6. Joseph Zhi Bin Ling & Albert K. Tsui & Zhaoyong Zhang, 2021. "Trading Macro-Cycles of Foreign Exchange Markets Using Hybrid Models," Sustainability, MDPI, vol. 13(17), pages 1-20, September.
    7. Mykola Babiak & Jozef Barunik, 2021. "Uncertainty Network Risk and Currency Returns," CERGE-EI Working Papers wp687, The Center for Economic Research and Graduate Education - Economics Institute, Prague.

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    More about this item

    Keywords

    business cycles; currency risk premium; Exchange Rates; Long-run risk;
    All these keywords.

    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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