Commodity Currency Crashes and Risk Premia

Currencies of resource-rich developed economies such as Australia, Canada and Norway are often called commodity currencies. These economies are intensive in exporting basic commodities. Dollar exchange rates of these currencies exhibit strong correlation with commodity prices. Empirically we find that commodity currencies feature high currency excess returns on carry-trade like strategies. Furthermore, these currencies typically crash in periods of significant negative returns to commodities, suggesting that commodity currencies inherit a risk premium due to their tendency to crash in disaster times. We model these properties of commodity currencies in a two country framework with complete markets, Epstein-Zin preferences and disaster risk. We find that recursive preferences are necessary in generating a higher interest rate in the commodity country, and can reproduce other features of the data such as negative skew of the real exchange rate and currency excess returns.