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WORKING PAPER

Global Risk Exposure to a Trade-Weighted Foreign Currency Index

Campbell R. Harvey

Duke University, Durham, NC 27708, USA

National Bureau of Economic Research, Cambridge, MA 02138, USA

Abstract

In most models of international asset pricing, exchange rate risk is priced. The purpose of this paper is to develop and analyze a new trade-weighted measure of the exchange value of the U.S. dollar versus 10 other currencies. The new index has two advantages over previous indices: the trade-weights are not assumed to be fixed over time and exchange investment returns, appreciation or depreciation in the value of the currency plus a Eurodeposit rate, are used rather than exchange rate changes. The new index can be interpreted as the return in excess of the Eurodollar rate of investing in a portfolio 10 local currency deposits. The portfolio weights vary as the relative trade shares evolve through time.