Do External Imbalances Matter in Explaining the Cross-Section of Currency Excess Returns?

External imbalance is a central variable in international economics and recent research shows it is priced in currency portfolios. But Ang et al. (2017), among others, show that with a small and time-varying cross section, tests with individual assets are preferable. We find testing with individual currencies matters. Going down from portfolio level to individual currencies, the estimated risk premium of external imbalances changes from a statistically significant 3.4% per year to an (insignificant) return of the opposite sign. Its premium is totally subsumed by carry. This suggests new currency factors should be tested using both individual currencies and portfolios