Technology Diffusion and Currency Carry Trades

Abstract

The paper identifies a unique dimension of currency carry trades that it is related to the intensity of technology transition across countries. Particularly, I show that technology diffusion is a fundamental determinant of currency premia and it is priced in the cross-section of currency excess returns. Technology spillovers are measured based on the R&D concentration as well as the inflows of foreign direct investment (FDI) that are associated with domestic patents owned by foreign investors. Intuitively, carry traders require a risk premium for financing risky innovation in countries with high patent related FDI inflows. Similarly, a positive risk premium is obtained from countries with high concentration of technology transition as investment currencies are subject to the R&D of the funding countries.