Currency Risk Factors in a Recursive Multicountry Economy

Focusing on the 10 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, heterogeneous 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, Roussanov, and Verdelhan and Della Corte, Riddiough, and Sarno.