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Commodity Trade and the Carry Trade: A Tale of Two Countries
Author(s) -
READY ROBERT,
ROUSSANOV NIKOLAI,
WARD COLIN
Publication year - 2017
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12546
Subject(s) - carry (investment) , economics , commodity , currency , productivity , monetary economics , profitability index , interest rate , international economics , exchange rate , terms of trade , production (economics) , general equilibrium theory , commodity swap , macroeconomics , financial economics , finance , futures contract
Persistent interest rate differentials account for much of the currency carry trade profitability. “Commodity currencies” offer high interest rates on average, while countries that export finished goods tend to have low interest rates. We develop a general equilibrium model of international trade and currency pricing where countries have an advantage in producing either basic inputs or final goods. In the model, domestic production insulates commodity‐producing countries from global productivity shocks, forcing final‐good producers to absorb them. Commodity‐currency exchange rates and risk premia increase with productivity differentials and trade frictions. These predictions are strongly supported in the data.