Nontraded Sector Growth Risks and Economic Sizes in International Asset Pricing

Abstract

Output fluctuations in nontraded sectors are an important country-specific risk factor because nontraded outputs are only consumed domestically. In interest rate markets, countries with higher nontraded output growth risks are associated with stronger motives for precautionary savings and lower interest rates. In currency markets, strategies with higher exposures to nontraded output growth risks offer higher average excess returns. Economic sizes play an important role in exacerbating the pricing impact of nontraded output growth risks as it requires larger international trades to mitigate nontraded output risks of larger economies. However, because economic sizes are functions of outputs in equilibrium, output growth risks also explain this role of economic sizes in international asset pricing. This paper was accepted by Agostino Capponi, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.03697 .