Macro Uncertainty and Currency Premia

This paper studies empirically the relation between macro uncertainty shocks and the cross-section of currency excess returns. We measure uncertainty over macro variables such as current account, ini¬‚ation rate, short-term interest rate, real economic growth and foreign exchange rate using the cross-sectional dispersion of market participants’ expectations from two international surveys of macro forecasts. We i¬ nd evidence that investment currencies deliver low returns whereas funding currencies oi¬€er a hedge when current account uncertainty is unexpectedly high. In contrast, uncertainty over other macro indicators displays no signii¬ cant relation with the cross-section of currency excess returns. Our results are consistent with a recent theory of exchange rate determination based on capital i¬‚ows in imperfect i¬ nancial markets.