Recent work in international finance suggests that the forward premium puzzle can be accounted for if (1) aggregate uncertainty is time-varying, and (2) countries have heterogeneous exposures to a world aggregate shock. We embed these features in a standard two-country real business cycle...

Fixing the investment horizon, the returns to currency carry trades decrease as the maturity of the foreign bonds increases. The local currency term premia, which increase with the maturity, offset the currency risk premia. The time-series predictability of foreign bond returns in dollars...

Since the fall of 2008, option smiles have been clearly asymmetric: out-of-the-money currency options point to large expected exchange rate depreciations (appreciations) for high (low) interest rate currencies, suggesting that disaster risk is priced in currency markets. To study the price of...

We find that deviations from the covered interest rate parity condition (CIP) imply large, persistent, and systematic arbitrage opportunities in one of the largest asset markets in the world. Contrary to the common view, these deviations for major currencies are not explained away by credit risk...

We identify a 'slope' factor in exchange rates. High interest rate currencies load more on this slope factor than low interest rate currencies. As a result, this factor can account for most of the cross-sectional variation in average excess returns between high and low interest rate currencies....

We set up an exponentially affine stochastic discount factor model for bond yields and stock returns in order to estimate the prices of aggregate risk. We use the estimated risk prices to compute the no-arbitrage price of a claim to aggregate consumption. The price-dividend ratio of this claim...

The U.S. consumption growth beta of an investment strategy that goes long in high interest rate currencies and short in low interest rate currencies is large and significant. The price of consumption risk is significantly different from zero, even after accounting for the sampling uncertainty...

We describe a novel currency investment strategy, the 'dollar carry trade,' which delivers large excess returns, uncorrelated with the returns on well-known carry trade strategies. Using a no-arbitrage model of exchange rates we show that these excess returns compensate U.S. investors for taking...

Aggregate consumption growth risk explains why low interest rate currencies do not appreciate as much as the interest rate differential and why high interest rate currencies do not depreciate as much as the interest rate differential. We sort foreign T-bills into portfolios based on the nominal...

Compared to the predictions of complete market models, actual exchange rates are puzzlingly smooth and only weakly correlated with macro-economic fundamentals, suggesting that market incompleteness plays a key role in exchange rate dynamics. Incompleteness in international financial markets...