DP12610 Currency Risk Factors in a Recursive Multicountry Economy

Author(s): Riccardo Colacito, Mariano Massimiliano Croce, Federico Gavazzoni, Robert Ready
Publication Date: January 2018
JEL(s): C62, F31, G12
Programme Areas: Financial Economics, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12610

Focusing on the ten most traded currencies, we provide empirical evidence regarding a significant heterogeneous exposure to global growth news shocks. We incorporate this empirical fact in a frictionless risk-sharing model with recursive preferences, multiple countries, and multiple consumption goods whose supply features both global and local short- and long-run shocks. Since news shocks are priced, heterogenous exposure to long-lasting global growth shocks results in a relevant reallocation of international resources and currency adjustments. Our unified framework replicates the properties of the HML-FX and HML-NFA carry-trade strategies studied by Lustig et al. (2011) and Della Corte et al. (2013).