Dominant Currency Pricing and Currency Risk Premia

Husnu Dalgic and Galip Kemal Ozhan

No 2026/158, IMF Working Papers from International Monetary Fund

Abstract: This paper studies how dominant-currency pricing affects currency risk premia. Empirically, we extract common risk factors from excess currency returns using principal components and relate countries’ factor exposures to observable macroeconomic characteristics, with export dollar invoicing emerging as a predictor of carry trade exposure. A small open-economy model with dominant-currency pricing and dollar-denominated liabilities explains why. Dollar export invoicing weakens the exchange rate's stabilizing effect on external demand, while dollar debt makes depreciation costly for leveraged intermediaries. When the two frictions interact, depreciations occur in bad states, local-currency assets become risky, the currency premium rises, and the risk-adjusted neutral rate increases. Under a standard Taylor rule, this mechanism generates persistently higher inflation.

Keywords: Currency returns; dominant currency pricing; uncovered interest parity; inflation; dollar debt; currency pricing; IMF working papers; export invoicing; dollar-denominated liability; Currencies; Exports; Exchange rates; Depreciation; Export prices; Global (search for similar items in EconPapers)
Pages: 86
Date: 2026-07-31
New Economics Papers: this item is included in nep-fmk, nep-mon and nep-opm
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