In the first chapter of this dissertation, I uncover an economic source of exposure to global risk that drives international asset prices. Countries which are more central in the global trade network have lower interest rates and currency risk premia. As a result, an investment strategy that is long in currencies of peripheral countries and short in currencies of central countries explains unconditional carry trade returns. To explain these findings, I present a general equilibrium model where central countries’ consumption growth is more exposed to global consumption growth shocks. This causes the currencies of central countries to appreciate in bad times, resulting in lower interest rates and currency risk premia. In the data, central countries’ consumption growth is more correlated with world consumption growth than peripheral countries’, further validating the proposed mechanism.

In the second chapter of this dissertation (with Hanno Lustig), we show that measures of distance explain exchange rate covariation. Exchange rates strongly co-vary across currencies against a base currency (e.g., the dollar). We uncover a gravity equation in the factor structure: The key determinant of a currency’s exchange rate (e.g., the CHF/USD) beta on the common base factor (e.g., the dollar factor) is the distance between this country (e.g., Switzerland) and the base country (e.g., the U.S.): the farther the country, the larger the beta. Shared language, legal origin, shared border, resource similarity and colonial linkages significantly lower the betas. On average, the exchange rates of peripheral countries tend to have high R2s in factor regressions, while central countries have low R2s. If the pricing kernel loadings on global risk factors are more similar for country pairs that are closer, a no-arbitrage model of interest rates and exchange rates replicates this distance-dependent factor structure.