NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Robert J. Richmond

Leonard N. Stern School of Business
Kaufman Management Center
44 West Fourth Street, 9-81
New York, NY 10012
Tel: 3036688773

E-Mail: EmailAddress: hidden: you can email any NBER-related person as first underscore last at nber dot org
Institutional Affiliation: New York University

NBER Working Papers and Publications

September 2017Gravity in FX R-Squared: Understanding the Factor Structure in Exchange Rates
with Hanno Lustig: w23773
We relate the risk characteristics of currencies to measures of physical, cultural, and institutional distance. The currencies of countries which are more distant from other countries are more exposed to systematic currency risk. This is due to a gravity effect in the factor structure of bilateral exchange rates: When a currency appreciates against a basket of all other currencies, its bilateral exchange rate appreciates more against the currencies of distant countries. As a result, currencies of peripheral countries are more exposed to the systematic variation than currencies of central countries. Trade network centrality is the best predictor of a currency’s average exposure to systematic risk.
 
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