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Currency Premia and Global Imbalances

Author

Listed:
  • Steven Riddiough

    (University of Warwick)

  • Lucio Sarno

    (City University London)

  • Pasquale Della Corte

    (Imperial College London)

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 recent exchange rate theory based on capital flows in imperfect financial markets. We also find that the global imbalance factor is priced in the cross sections of other major asset markets.

Suggested Citation

  • Steven Riddiough & Lucio Sarno & Pasquale Della Corte, 2015. "Currency Premia and Global Imbalances," 2015 Meeting Papers 1215, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:1215
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • 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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