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Business Cycles and Currency Returns

Author

Listed:
  • Sarno, Lucio
  • Colacito, Ric
  • Riddiough, Steven
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.

Suggested Citation

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

    1. Lloyd, S. P. & Marin, E. A., 2019. "Exchange Rate Risk and Business Cycles," Cambridge Working Papers in Economics 1996, Faculty of Economics, University of Cambridge.
    2. Ferrari, Massimo & Kearns, Jonathan & Schrimpf, Andreas, 2021. "Monetary policy’s rising FX impact in the era of ultra-low rates," Journal of Banking & Finance, Elsevier, vol. 129(C).
    3. Chen, Shiu-Sheng & Chou, Yu-Hsi, 2023. "Liquidity yield and exchange rate predictability," Journal of International Money and Finance, Elsevier, vol. 137(C).
    4. Anna Sznajderska, 2021. "The Impact of Foreign Shocks on the Polish Economy," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 1, pages 33-52.
    5. Trancoso, Tiago & Gomes, Sofia, 2023. "Beyond the dollar: A global perspective on exchange rate dynamics via currency factors," Finance Research Letters, Elsevier, vol. 58(PA).
    6. Libo Yin & Jing Nie, 2021. "Intermediary asset pricing in currency carry trade returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(8), pages 1241-1267, August.
    7. Zhang, Shaojun, 2022. "Dissecting currency momentum," Journal of Financial Economics, Elsevier, vol. 144(1), pages 154-173.
    8. Engel, Charles & Kazakova, Katya & Wang, Mengqi & Xiang, Nan, 2022. "A reconsideration of the failure of uncovered interest parity for the U.S. dollar," Journal of International Economics, Elsevier, vol. 136(C).
    9. Hsu, Po-Hsuan & Taylor, Mark P. & Wang, Zigan & Xu, Qi, 2022. "Currency volatility and global technological innovation," Journal of International Economics, Elsevier, vol. 137(C).
    10. Fernanda Gonçalves & Giuliano Ferreira & Alex Ferreira & Pedro Scatimburgo, 2022. "Currency returns and systematic risk," Manchester School, University of Manchester, vol. 90(6), pages 609-647, December.
    11. Kwas, Marek & Beckmann, Joscha & Rubaszek, Michał, 2024. "Are consensus FX forecasts valuable for investors?," International Journal of Forecasting, Elsevier, vol. 40(1), pages 268-284.
    12. Bartram, Söhnke & Djuranovik, Leslie & Garratt, Anthony, 2021. "Currency Anomalies," CEPR Discussion Papers 15653, C.E.P.R. Discussion Papers.
    13. Ca’ Zorzi, Michele & Rubaszek, Michał, 2023. "How many fundamentals should we include in the behavioral equilibrium exchange rate model?," Economic Modelling, Elsevier, vol. 118(C).
    14. Mykola Babiak & Jozef Barunik, 2021. "Currency Network Risk," Papers 2101.09738, arXiv.org, revised Jul 2021.
    15. Tsiakas, Ilias & Li, Jiahan & Zhang, Haibin, 2020. "Equity premium prediction and the state of the economy," Journal of Empirical Finance, Elsevier, vol. 58(C), pages 75-95.
    16. He, Hongbo & Chen, Yiqing & Wan, Hong & Yao, Shujie, 2023. "Possibility versus feasibility: International portfolio diversification under financial liberalization," International Review of Financial Analysis, Elsevier, vol. 87(C).
    17. Peter Hördahl & Giorgio Valente, 2022. "Emerging market bond flows and exchange rate returns," BIS Working Papers 1042, Bank for International Settlements.
    18. Liu, Xi & Zhang, Xueyong, 2024. "Geopolitical risk and currency returns," Journal of Banking & Finance, Elsevier, vol. 161(C).
    19. 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.
    20. Rubaszek, Michał & Beckmann, Joscha & Ca' Zorzi, Michele & Kwas, Marek, 2022. "Boosting carry with equilibrium exchange rate estimates," Working Paper Series 2731, European Central Bank.
    21. Bazán, Walter & Ortiz, Marco & Terrones, Marco & Winkelried, Diego, 2023. "CIP deviations: The role of U.S. banks’ liquidity and regulations," MPRA Paper 118600, University Library of Munich, Germany.
    22. 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.
    23. Yu‐Hsi Chou & Chia‐Yi Yen, 2023. "Convenience yield and real exchange rate dynamics: A present‐value interpretation," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 56(2), pages 453-489, May.
    24. Dupuy, Philippe, 2021. "Risk-adjusted return managed carry trade," Journal of Banking & Finance, Elsevier, vol. 129(C).

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    More about this item

    Keywords

    Exchange rates; Currency risk premium; Business cycles; 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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