Business cycles and currency returns

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...

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Bibliographic Details
Published inJournal of financial economics Vol. 137; no. 3; pp. 659 - 678
Main Authors Colacito, Riccardo, Riddiough, Steven J., Sarno, Lucio
Format Journal Article
LanguageEnglish
Published Amsterdam Elsevier B.V 01.09.2020
Elsevier Sequoia S.A
Subjects
Asset pricing
Business cycles
Currency
Currency risk premium
Economics
Exchange rates
Foreign exchange rates
Investment policy
Long-run risk
Money
Risk factors
Time series
Exchange rates
Business cycles
Long-run risk
F31
Currency risk premium
G12
G15
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Summary: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.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2020.04.005