Trade Network Centrality and the Currency Carry Trade

Abstract

I uncover an economic source of exposure to global risk that drives international asset prices. Countries which are more central in the global trade network have lower interest rates and currency risk premia. As a result, an investment strategy that is long in currencies of peripheral countries and short in currencies of central countries explains unconditional carry trade returns. To explain these findings, I present a general equilibrium model where central countries’ consumption growth is more exposed to global consumption growth shocks. This causes the currencies of central countries to appreciate in bad times, resulting in lower interest rates and currency risk premia. In the data, central countries’ consumption growth is more correlated with world consumption growth than peripheral countries’, further validating the proposed mechanism.